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Dollars inflows: Turning the tap off - Views on News from Equitymaster

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Dollars inflows: Turning the tap off
Aug 8, 2007

The Government of India's new guidelines on External Commercial Borrowings (ECBs) will help the Reserve Bank of India's efforts on keeping the Rupee from strengthening any further. Now the ECBs above US$ 20 m can be raised only for permissible end-uses and the funds need to be parked abroad so that they can be used just for foreign currency expenditures. In May 2007, the RBI had lowered the maximum permissible interest rate at which medium term maturity ECBs could be raised from 3.5% above LIBOR to 2.5% above LIBOR. A low credit rating from Moody's and a just about investment grade from S&P will reduce the arbitrage opportunity that exists in borrowing euro, yen, or dollar denominated loans when domestic Indian interest rates are high. This will strongly impede Indian corporates from raising cheap funds abroad to spend on Rupee expenditures.

As we had mentioned in our columns last week, it was the ECB inflows of about US$ 8.7 bn along with an almost equal amount of US$ 8.4 bn in FII money that poured in during the same time, we had almost US$ 17 bn of volatile money flooding the Indian markets in just three months. These changes in ECB guidelines will turn the tap off on dollars. Also the sub-prime bonds crisis has seen some of the FII profit booking on the Indian stock markets. That again adds to dollars being taken out. The impact on market sentiment will be enough to get the Rupee to depreciate over the next few weeks. These measures strengthen our existing view of a dollar exchange parity of about US$ 44 by March 2008.

By making Indians raising debt in excess of US$ 20 m to fund just dollar expenditures (for buying equipment, etc.) and that too to be parked abroad till as such time as it is required, will turn a currency capital inflow into actual building of infrastructure or capital formation in India. In one stroke the dollar inflows are reduced, but at the same time, the pressure on dollars in the Indian markets will not be there to depreciate the rupee far too much.

This should bring some semblance of sanity in the reserve money supply that has been galloping at the rate of 29%. The bank credit growth that has slowed down from 32% to 33% to around 24% in the last five months should also turn around, as the corporates will be forced to now borrow in Rupees to spend in Rupees. This will be good news for exporters as on one hand the commerce ministry has managed to give them tax breaks recently, while the reason for their misery will now be eased!! So overall, the government has acted in collusion with the RBI to address pressing issues that faced the Indian economy.

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