Rupee fall stokes investors' fears about policymaking

The rupee tumbled to Rs 59.93 against the US dollar early into Thursday's trading, which serves as a measure of India's economic weakness, and the market's fear that policymakers have practically nothing left in their toolkits to defend the currency.

According to Reuters, finance ministry's chief economic advisor Raghuram G. Rajan said: "We should not let ourselves be led by the markets into directions we don't want to go. Let me emphasise, we are not short of actions and instruments if and when the need arises."

It is hard to see why the currency market will take Rajan seriously. A week ago his boss, finance minister P.Chidambaram had said, "I don't think there's any reason for panic."

In three of the four equity and debt market trading sessions since Chidambaram's attempt to soothe frayed nerves, foreign institutional investors (FIIs), were net sellers. In June (till the 19th), FIIs have been net sellers to the extent of $4 billion.

The impact showed in the BSE Sensex. In June, the Sensex was down 4.3 per cent trading at around 18,766 points at 2.40 pm on Thursday.

Thursday's sell-off in the currency and securities markets comes on the heels of a statement by the U.S. Federal Open Market Committee (FOMC) the previous evening. FOMC formulates and conducts monetary policy. The statement showed FOMC members had a positive outlook on the U.S. economy and employment.

"The Committee sees the downside risks to the outlook for the economy and the labour market as having diminished since the fall," the statement said. FOMC also decided to continue with its monetary stimulus, or quantitative easing (QE). However, FOMC's positive outlook has triggered a pullout of money from emerging markets such as India back to the U.S. as institutional investors anticipate hardening of interest rates there, making U.S. debt relatively more attractive.

India's policy makers can do little about the fallout of a global movement of funds. But what makes things worse is that the US recovery has coincided with a period of unprecedented weakness in India's balance of payments (BoP) and a slowdown in economic growth, leaving the economy with no cushion to deal with events beyond its control. In the October-December quarter of 2012, India's current account deficit was a record 6.7 per cent of gross domestic product and the economy in 2012/13 grew just five per cent, the slowest growth rate in a decade.

The Reserve Bank of India is no position to defend the rupee beyond sporadic interventions. Foreign currency reserves on 7 June 2013 stood at $260 billion, as compared to $ 300 billion five years ago.

High inflation between 2010 and 2012 has also had a knock-on effect on BoP, by influencing household behavior. Gold imports, driven increasingly by households trying to insulate themselves from inflation, now makes up about 10 per cent of India's imports. Without anything left in his toolkit to change household behavior, Chidambaram a week ago was reduced to announcing his savings pattern as a way to wean people away from gold. "I don't buy gold," said Chidambaram at a press conference on June 13. "I put my money in financial instruments."

Little wonder the markets don't take India's policy makers seriously.