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Rupee may pare gains on rising trade deficit

Last week, the government enhanced the borrowing limit from overseas to $100 million for infrastructure and services sector companies like hospitals, hotels and software services.

business Updated: Jun 02, 2008 20:39 IST
Arun Kumar
Arun Kumar
Hindustan Times

The rupee got a boost on Monday following the government's decision to ease curbs on overseas borrowing by Indian companies, but a widening trade gap and sustained withdrawal by foreign investors from the stock market could undo the gains.

Last week, the government enhanced the borrowing limit from overseas to $100 million for infrastructure and services sector companies like hospitals, hotels and software services. The move came amid a sudden depreciation of rupee -- the Indian currency has fallen 6.5 per cent to 42.59 to a dollar through April and May, according to RBI -- and contrast earlier stance of the country's monetary authorities.

Around same time last year, RBI had imposed restrictions on external commercial borrowings (ECBs) and the stock market regulator, SEBI, had brought curbs on investment through the so-called participatory notes in a bid to moderate inflow of foreing money. Finance Minister P Chidambaram had then described the inflows as "copius."

"Then, the issue was of managing the plenty, since dollars were pouring into India," said KC Chakrabarty, chairman and managing director, Punjab National Bank. "Now we are in a completely different situation. Though the exact inflow through remittances and software exports is not yet known, there are signs that they have declined and the rupee has started weakening against dollar causing problem for oil import bill."

Last year, foreign institutional investors (FIIs) had taken out a net $3.8 billion in the first five months (January-May) of 2008 from the Indian markets as against a net investment of $3.9 billion. In 2007, FIIs had invested $17.2 billion in Indian equities, and as per current indications, this year’s figures are likely to be lower, said Amitabh Chakraborty, president and head of equities, Religare Securities.

Companies are enthusiastic. "Since the healthcare sector has a long term gestation period as in case of infrastructure, the move will help the sector achieve financial closure and improve margins," said Analjit Singh, chairman and managing director, Max Group, which has interests in healthcare, insurance and telecom.

"Last time, we borrowed from International Finance Corporation (IFC), we had to convert part of the loan into equity. Now we can access the global market to raise at competitive rates," he added.

Experts feel that fall in the value of the rupee adversely affects inflation and increases government burden on oil, food and fertilisers --- India is a net importer of crude oil (which gets converted into fuel and fertiliser), edible oil and wheat.

"A 1 per cent rupee depreciation causes an approximately 3 per cent increase in oil under recovery," said Nilesh Jasani, research analyst, Credit Suisse. "Together with a fertiliser deficit, we estimate that a 1 per cent rupee fall to cause an additional Rs 7,000 crore in government deficit, about 0.15 per cent of GDP."

As a result, "In an environment where oil, food, and fertiliser deficit are nearly double those of same time last year, the burden is costly, not just for the government but for the entire economy," Jasani added.

Many Indian companies are in a bind over the sudden and sharp depreciation of the rupee. After the volatile and continuous appreciation of rupee, many software and outsourcing companies entered into agreements where a fluctuation of 2.5 per cent either way would result in a re-negotiation of contract to protect the companies from a currency downside.

"Post rupee depreciation, foreign companies are now re-visiting contracts so that they can adjust the price," said the chief financial officer of a software company on the condition of anonymity.