Harder the RBI tries to stabilise the rupee, stricter it gets in its actions. In spite of that the rupee is showing inordinate stubbornness and denying RBI a commanding position. So far, RBI has taken measures to draw out liquidity by making short term borrowing pricy. Moreover, it has prescribed a limit on borrowing by banks under Liquidity Adjustment Facility (LAF) window to meet their short term liquidity requirements.
This was expected to discourage speculation in the forex market which was believed to be one of the reasons behind incessant fall in the rupee. It has been almost three weeks since RBI stared intervening aggressively, but all actions taken by the central bank have gone in vain thus far. Although tight liquidity is intimidating investors as it threatens to affect growth prospects of the fractured domestic economy, there’s something to cheer for.
How investors may still benefit?
Given the tight liquidity situation, investors have a chance to earn higher returns on their fixed deposits with banks.
Many, including the finance minister, had expressed that they believed these measures were short term in nature. However, there was a question mark on how one defines short term. Finally, RBI broke its silence at the first quarter review of monetary policy by stating that the measures would remain in place till rupee becomes stable. Although the monetary policy statement didn’t hint at any possible hike in policy rates, it certainly did reiterate that currency stability remains high on its agenda.
How lengthy the rupee recovery may be?
Although dollar strength is one of the reasons for weakness in the rupee, shortcomings of domestic economy are pushing it further down. Industrial growth is stalled and economy is expected to grow at snail’s pace in the current financial year. RBI too has lowered its GDP growth forecast to 5.5% which is lower than 5.7% projected earlier. Unsustainable deficits in the current account of the nation are widely known already.
At the time when India needs to attract more foreign capital; it is finding it difficult even to retain existing foreign investors who are selling their investments in India and exiting. This is putting more pressure on rupee and nullifying the moves of RBI. This trend is difficult to reverse unless government policies succeed in reassuring foreign investors that India would attain decent growth and investment environment would be upbeat.
This means contrary to the belief of many, liquidity may remain tight for longer than expected. When banks are starved for funds they would be forced to hike interest rates on deposits to attract money from public. This process has already started with many banks revising interest rates on deposits. Also, RBI has lowered its inflation guidance and expects inflation to be around 5% in the current financial year. Firm monsoon is also expected to result in bumper harvest this year and may help lower food inflation and indirectly the retail inflation. Lower inflation expectation and possibility of hike in the deposit rates may push your real rate of return higher.
What should investors do?
PersonalFN is of the view that, you as an investor should take advantage of the prevailing situation and even consider investing in fixed deposits. However, investors shouldn’t over commit and follow their personalised asset allocation. Don’t forget, any rise in crude oil prices at international level would again give rise to higher inflation in the domestic economy. But fixed deposits, especially the short term ones certainly have started looking attractive again.
PersonalFN is a Mumbai based Financial Planning and Mutual Fund Research Firm.