Money matters

Only a calculated economic and monetary policy can revive the rupee, write Navin Syiem and Anjan Dasgupta at HSA Advocates

The steep fall of the Indian rupee can be attributed to various factors, including the slow progress of economic reforms, which has led to a decline in foreign direct investment (FDI), and an announcement of quantitative easing in the US, which has prompted investors to pull out of India and focus on other economies. Since May alone, the rupee has plummeted approximately 16%.

Propping up the rupee

The Reserve Bank of India (RBI) seems to have adopted a monetary policy designed to suck liquidity out of the country’s financial system in an effort to prop up the rupee. For example, the RBI’s liquidity adjustment facility (LAF) – under which domestic banks can access funds from the RBI – has been reduced in size, limiting access to these borrowed funds. Bank borrowings from the LAF facility will be cut in half and if banks want more funds, they can borrow from the RBI under the marginal standing facility at an interest rate of 10.25%. Such a measure could remove liquidity from the financial system by making commercial loans more expensive.

Similarly, short-term interest rates have been raised to arrest the fall of the rupee. The interest rate for the marginal standing facility (under which banks can borrow funds from the RBI by pledging approved government securities) was raised to 10.25% from 8.25%, thereby increasing borrowing costs for banks. Other measures adopted by the RBI to reduce liquidity include a bond sale. Bonds worth ₹25.32 billion (US$411 million) were sold by the RBI in the secondary market on 18 July.

The RBI has not been forthcoming about its plans to reverse the steps it has taken to tighten liquidity. Bankers have already expressed concerns, indicating that their profitability may take a hit if these measures continue for more than four to six weeks.

Navin Syiem and Anjan Dasgupta are partners at HSA Advocates and can be contacted at navin.syiem@hsalegal.com and anjan.dasgupta@hsalegal.com. The authors thank Shraddha Malhotra (an associate at HSA Advocates) for her contributions to this article.