RBI announced some measures to slow the Indian Rupee fall, so that the economy has time to adjust. Of these measures, only the US$5 bn increase in FII limit for G-Secs is meaningful (hedging will likely reduce impact). It seems to be a safe measure, as external debt is only 20% of GDP. However, the increase in FII debt limit has been parabolic of late, while it helps the INR near term, it sharply increases medium-term risks.
While the increase in foreign debt is likely to slow the rupee’s fall near term, it increases risks over the medium term. External debt to GDP in
India is still a low 20%; so despite this ratio potentially rising by 2 pp in FY13, there is little risk of this debt going out of hand anytime soon. The almost parabolic rise in limit for FII debt since 2008, when the fiscal deficits started to balloon, is thus worrying. As lock-in requirements on FII debt holdings are relaxed, capital flows are likely to rise, further reducing the RBI’s ability to intervene in the markets if necessary.
While continuing deficit monetisation is an overhang, we do not believe the currency will drive a crisis (i.e., sudden capital flight/shortage of reserves). The economy takes time to adjust to new currency levels, but auto-stability is possible at current levels.
