Dr. Raghuram Rajan, you are one of the very few economists worldwide who understand markets and we all respect you for that very reason. You do not let esoteric economic theory affect your practical views on market behaviour.
India desperately requires your market sense now.
The media hype over the INR fall to record lows of close to Rs 60 to the USD would suggest that the INR is reflecting every thing wrong with India from high current account deficit to even every day law and order situation. The blame on the INR fall is also squarely placed on FII selling of INR bonds. FII’s have sold USD 4.5 billion of bonds over the last one month and this selling is seen to have taken the INR down by 11% over the same period.
It is true that FII selling of bonds and the INR fall was in tandem but looking at it from an overall perspective, the fact that selling in emerging market assets including equities, currencies and credits was the norm for global traders, hedge funds and investors. The broad sell off in emerging market assets was sparked off by the Fed indicating withdrawal of bond purchases.
The INR fall to record lows is now inviting speculation of rate hikes, capital controls, policy intervention and other such unwanted opinions. Even a seasoned trader can fall into the trap of the hype over the INR fall and hence your calming comments on the INR fall being no big deal is falling on deaf ears.
It is true that a weak INR can lead to many ills in the economy but we have seen in the past in India that every time the INR had fallen to record lows, the economy had actually bounced back stronger. The beginning of the 2000s decade is a case in point. However, India is still not mature enough to accept INR weakness without creating the kind of hype that is being created now.
Higher Debt Limits Require Maturity
FII debt limits have been increased from below USD 3 billion to USD 80 billion over the last ten years. The pace of increase has been the highest in the last three years with USD 50 billion limit increase for FII investments in INR bonds. However FII’s had filled up less than half the debt limits before the selling started in May 2013.
The domestic bond market has not really been shaken by the FII selling. Bond yields across government and corporate bonds have gone up 30bps over the last one month but the same is true of US treasury yields that have gone up by close to 50bps. FII selling of USD 4.5 billion of INR bonds should ideally have had a much more negative impact on the bond market in India, but it has not.
The fact that money markets are well in order without undue liquidity tightness or higher money market rates actually prove a point that FII selling of INR bonds has not been disruptive. System liquidity as measured by the bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI has actually eased by Rs 20,000 crores over the last one month. Overnight money market rates are stable at around repo rate levels of 7.25%.
The bond market is behaving well with FII selling but not the currency market. This brings on the question of whether India needs higher debt flows or not if any negative action by FIIs on debt is going disrupt the currency market. It will never be a case where flows are only one way i.e. inward, there will always be points of time when FIIs sell bonds just like any other investor would do if factors for interest rates are negative. No FII will come into India for the love of the country. FIIs will come in for returns and if returns are threatened they will sell.
Dr. Rajan please do advice the policy makers not to run after USD flows into domestic debt. The country requires a much freer movement of capital for that and the INR is still not fully capital account convertible. India also lacks the maturity to handle negative flows and negative flows will happen many times going forward.
Opening the market to hold to maturity investors such as global pension funds and sovereign funds is fine but that can be addressed through private placements and not through an overall increase in debt limits for the category of FIIs.
India does require your expertise on markets now.