The Hindu Business Line : ECB curbs and market-control measures

Given the current state of market development and the multiple responsibilities which the RBI shoulders, resorting to direct market-control measures does appear inevitable.

These are times when direct and administrative control measures are back in favour with the market regulators, particularly in emerging markets such as India and China.

Such administrative control measures have so far been mainly in the banking/foreign exchange markets in India, though the Chinese authorities also recently exercised themselves in the stock market.

Resorting to administrative control measures is a clear reminder that financial markets development is an unfinished task in the emerging economies.

Frequently, prices (of various financial assets such as bonds or foreign exchange) or liquidity in the financial system/the growth of credit aggregates and so on acquire a certain momentum and become somewhat impervious to the normal market-based mechanisms designed to influence them.

Monetary authorities in India, for instance, have gone the way of their Chinese counterparts in directly impounding the lendable resources of the banking system after finding that price signalling through daily market operations failed to pack enough punch.

The Reserve Bank of India's move, earlier this week, to bar External Commercial Borrowings completely for the real-estate sector is another example of resorting to direct market-control measures.

With this move, the RBI expects to staunch the inflow of foreign exchange at least to some extent, prevent the creation of what it feels as unnecessary rupee liquidity in the current environment and, thereby, moderate demand-side pressures in the economy.

Inevitable, but is there a choice?

Given the current state of market development and the multiple responsibilities that the Reserve Bank of India shoulders, resorting to direct market-control measures (at a certain point in time after exhausting market-based measures) does appear somewhat inevitable in the Indian context. Given that it is a necessary evil, the challenge is if the RBI has a choice even among the not-so-palatable policy options.

In the immediate situation, one wonders if the central bank could have tried to attain the same objectives listed above — slowing down the inflow of foreign exchange and preventing the creation of unwanted rupee liquidity — through alternative measures which could have been classified as a lesser evil but also could have larger systemic benefits?

Hedging of ECBs

An analysis of the issue indicates that the RBI could have indeed resorted to alternative measures which may have helped in attaining the same core objective of preventing or minimising the creation of the unwanted rupee liquidity at this juncture.

A stronger message (than hitherto given by the RBI on this issue) or even a directive from the central bank on hedging the currency risk carried on the foreign currency borrowings could have been a policy choice.

This directive or recommendation could have been suitably structured in terms of various loan parameters such as tenor, amount and currency of borrowing.

An enhanced level of hedging of outstanding foreign currency loans would amplify the demand for foreign exchange and serve to moderate the upward pressure on the rupee's exchange rate.

That could, in turn, help the RBI to bring down the level of its market intervention and minimise the creation of rupee liquidity to some extent.

Outstanding commercial borrowings stock is around $25 billion currently and a fair degree of demand for foreign exchange could emanate from any increased hedging with respect to this outstanding stock.

Attractive hedging levels

Long-term (up to five years) foreign currency hedging costs are at fairly attractive levels.

A company which has medium/long-term foreign currency (dollar) borrowings can fully hedge its exchange rate and interest rate risks (the risk of the rupee falling against the dollar over the tenor of the loan as well as the risk of the foreign currency interest rate rising) at a fixed rate of around 11 per cent currently.

At these levels, therefore, even fully hedged foreign currency borrowings compare favourably with local currency borrowing rates of 12 per cent-plus.

This has been the case for quite some time in the markets and the fact that the fully-hedged foreign currency cost has continued to rule lower than the local currency cost is a pointer to the low level of hedging which actually takes place.

Not fully optimal but de-risking achieved

While such hedging may not be fully optimal from the borrowers' point of view, it nevertheless would remove the uncertainty regarding his financing costs on at least a portion of his total liabilities stock.

A certain degree of de-risking in the overall system also would be achieved through such enhanced hedging.

Overall, though, it would continue to be a challenge for regulators to find the right mix of market and non-market based measures to deal with market trends not entirely in tune with their preferences.

More Stories on : Financial Markets | Insight | RBI & Other Central Banks

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Tangled trade

Growth, inflation and interest rates

Exports, more than rupee's worth

Three years of UPA Government — Importance of looking earnest

A new Raja

Fuelling speculation

A taste of mangoes

ECB curbs and market-control measures — Does the RBI have a choice?

Exit Paul Wolfowitz

Real inclusion