RBI's innovative approach to control the fall in rupee is commendable

The efficacy of the central bank's steps will be seen in the coming days

The fall of the rupee has been driven by both fundamentals as well as external forces. A stronger dollar compared with the euro automatically leads to decline in value of all currencies. Simultaneously, the impact of higher interest rates in the US also means that investment flows turn around. A combination of these two factors has led to the rupee now crossing the $79 mark and moving towards 80. In such a situation what can the Reserve Bank of India (RBI) do?

The RBI has always maintained that it has various options to tackle a volatile rupee. Direct selling of dollars is now passé. Swaps of the sell-buy variety too may have lost their sting while dealings in the forward market has its limitations. The NDF market has also been experimented with certain positive effects. But clearly there are limits to such operations and a mélange is the way out on the direct side.

The RBI has now turned to the capital account to see if there are regulatory issues that can be eased to allow for more inflows. The current account is hard to control as almost all transactions are free (LERMS does put some limits) from regulation. The capital account however has some regulatory reins that are used by the central banks. Here the RBI has now come out with some new rules at liberalisation of forex flows. As there are time limits specified for each one of them (around 4-6 months), they can be interpreted as being transient in nature to tackle a problem which does not seem to end.

Three areas that have been liberalised are NRI deposits, FPI flows and ECBs. All have the potential to improve the flow of capital that can have a soothing effect on the fundamentals. On NRI deposits, the RBI has allowed banks to raise fresh deposits without constraints such as interest rates being beyond the extant rules of alternative reference rate or domestic rates. The fact that these deposits will be free from CRR and SLR requirements gives banks the incentive to push for these deposits as well as pass on the cost benefit to the deposit holder in the form of higher interest rates. Will this being in higher deposits? To an extent, yes, but given that this will be a relaxation till only October 31, banks will be competing with options of rising rates in the rest of the world, there may be limits.

Similarly, for FPIs, greater access has been provided to these funds for both government and corporate debt. Given the interest rate environment across alternative markets and the general lack of interest in corporate debt, the flow of funds may again be limited. But to the extent that funds are looking for shorter term alternative investment options, this can help.

Last, the RBI has allowed companies to raise funds through the ECB route up to $ 1.5 bn instead of $ 750 million with the all-inclusive cost being raised by 100 bps. This should be an incentive for sure for companies to borrow from this route as the time line is up to December 31 2022. Here, the limitation will be that ECBs are today not too attractive given the rising interest rate scenario coupled with volatile rupee- both of which increases the cost of such loans.

The RBI hence can be commended for enlarging the armory of tools being used to control rupee volatility. The efficacy will be seen in the coming days. From the sentiment side, these measures are good as the rupee should gain some strength. But for how long will be question as capital flows under these heads must be substantial to make a real difference.

(The writer is Chief Economist, Bank of Baroda and author of: 'Lockdown or economic Destruction'. Views expressed in this article are personal.)