INDIAN STOCK MARKET

While the Indian central bank’s foreign exchange reserves stand at a record $301.2 billion with at least $100 billion having been added during the current fiscal year, there is an acute dollar shortage in the market.
“There is hardly any dollars in the market. The banks have no dollars to lend to corporations,” says the India chief executive of a large foreign bank who didn’t want to be identified. Foreign exchange dealers estimate that Indian banks are facing a shortfall of about $200 million every day for the past month.
Meanwhile, the rupee fell 0.70% to close at 40.52/53 to a dollar on Friday, its lowest in six months, taking cues from the falling equity markets.
EQUITY IMPACT
The dealers are blaming the Reserve Bank of India (RBI) and the finance ministry’s policy of curbing dollar inflows for the systemic shortages. While the curb on external commercial borrowings (ECBs) considerably slowed the inflow of dollar funds, the sub-prime crisis that continues to rock the world’s financial system virtually shut the door for Indian firms for foreign currency convertible bonds (FCCBs).
“The shortage of dollars has persisted for almost a month, primarily owing to outsized capital outflows in the past six weeks. The situation will correct only when inflows recover sufficiently or the RBI supplies dollars ... To be sure, the worst of the dollar shortage is likely behind us but, it is still uncertain when onshore dollar liquidity fully normalizes,” said Vikas Agarwal, an analyst with JPMorgan Chase Bank.
However, there are others who say that the situation will worsen in the second half of March when the rupee liquidity will tighten on account of advance tax outflows. Indian firms pay advance corporate tax every quarter and analsysts say the quantum varies between Rs40,000 crore and Rs50,000 crore, depending on the profitability of companies. “With rupee liquidity tightening, RBI may not like to rollover its forward purchase of dollars as part of its sell-buy swaps in the market,” pointed out the dealer at the private bank.
Meanwhile, there are other factors that have also contributed to the dollar shortage.
One of them is a considerable slowdown in the flow of money from non-resident Indians, or NRIs. They are remitting less money to India as interest rates offered on so-called NRI deposits have come down sharply. For instance, until mid-April 2007, NRIs were offered 25 basis points less than the Libor (London Interbank Offered Rate) on their dollar deposits. Now, the rate is 75 basis points less than Libor.
To add to their woes, with the cut in US Fed rates, six-month Libor has come down from 5.30% a year ago to 2.88% now. This means, interest rate on six-month dollar deposits or FCNR(B) deposits has come down sharply from 5.05% to 2.13% in one year. The US Fed rate has come down from 5.25% to 3% since September 2007.
Between April and December, 2007, there was an outflow of $364 million from Indian banks’ FCNR(B) deposit portfolio. In the corresponding period of the previous year, there was an inflow of $1.6 billion. “The story is very similar in other NRI deposits too,” said a foreign exchange dealer with a new private bank who too didn’t want to be identified. There are two other NRI deposits—NRO and NR(E)RA—and banks have brought down interest rates on both in the past one year. Overall, there was an outflow of $816 million in the April-December period compared with an inflow of $3.7 billion in the corresponding period of the previous year.
Another factor in the dollar shortage is that foreign institutional investors (FIIs) areturning net sellers in the Indian equities.
Since the beginning of this year, FIIs have net sold $3.3 billion worth of equities. In 2007, they had bought a record $17.5 billon worth of Indian equities net of sales.
Meanwhile, RBI has been conducting sell-buy swaps in the foreign exchange market to drain liquidity. The sell-buy swaps postpone the creation of rupee liquidity immediately after RBI’s intervention in the foreign exchange market. The swap involves selling dollars with a simultaneous agreement to buy them back at a future date at a specified price. This is nothing but a forward contract.
When the time comes to buy back these dollars, RBI reviews the liquidity situation and either roll over such swaps or convert the dollars into local currency.
“If it rolls over the contract, dollars will remain in the system but since RBI may like to generate rupee liquidity to take care of the temporary tightness that will be created on account of advance tax outflows, it will buy back the dollars. This will worsen the dollar shortage,” the dealer said.
In August 2007, the finance ministry introduced stringent norms for Indian companies raising cheap dollar loans through the ECB route. Now ECBs of up to $20 million are permitted with a minimum average maturity of three years, and over $20 million and up to $500 million per borrower are permitted with a minimum average maturity of five years.
There were also restrictions in terms of use of ECBs. The government stipulated that the ECB proceeds can be used primarily for import of capital goods, new projects, modernization or expansion of existing projects in the realty sector and for the infrastructure industry.
ECBs accounted for $16 billion out of the $36 billion foreign exchange inflows in 2006-07. In the April-September 2007 period, loans raised via ECB were about $10 billion.
Harihar Krishnamurthy, head of treasury at Development Credit Bank, said the ECB routes should be opened up and NRI deposits be paid higher interest rates.