Reprieve to rupee, bond markets is short-term

The rupee has recovered to 94.4 to the US dollar, from an all-time-low of 96.6 on May 20. Over this period, 10-year Indian government bond yields, too, have softened from over 7.1 per cent to below 6.8 per cent. Brent crude prices closed on Friday at $72.6 per barrel, having risen as high as $126.4 in end-April. India’s latest urea import contracts have been at $444.9-449.3 per tonne, as against $935-959 in April. Foreign portfolio investors (FPI) have started putting money again in India, investing nearly $5.2 billion into debt so far in June, compared to $291 million, minus 1.2 billion and minus $926 million in the preceding three months. All these are suggestive of the Indian economy returning to the pre-war situation, with an easing of tensions in West Asia and the associated supply shocks.

The reduction in macroeconomic stress may, however, be temporary, and arguably as fragile as the US-Iran truce. The renewed hostilities since Thursday — with daily vessel crossings through the Strait of Hormuz still half of what they were in peacetime — are a reminder of that. The Rs 10/litre excise duty cut on transport fuels in late-March, and the fertiliser subsidy outgo, likely to significantly overshoot budget estimates despite the recent global price dip, will continue to exert pressure on the Centre’s finances. FPIs remain net sellers in Indian equity markets, with outflows of $5.5 billion-plus this month on top of $3.5 billion, $6.5 billion and $12.7 billion in May, April and March respectively. The rupee’s stabilisation for now is courtesy the coordinated government-Reserve Bank actions to attract foreign inflows through sovereign debt, non-resident/FCNR(B) deposits and external commercial borrowings (ECB). These measures — whether offering complete tax exemption on FPI investments in government bonds or at-par/concessional dollar-rupee swap facilities on FCNR(B) deposits and ECBs — aren’t costless. A deficit monsoon — 43 per cent below-rainfall in June even before El Niño is to fully bite — adds to the vulnerabilities.

Simply put, the reprieve to the rupee and bond markets is short-term at best. As a large lower middle-income emerging economy, India should be attracting foreign investment more in the form of equity than debt. That is conditional upon investor confidence, both domestic and foreign, in the country’s growth story as well as macroeconomic stability. All the more reason for policymakers to double down on domestic reforms — economic, legal and institutional — even amid global uncertainty and fiscal consolidation in order to reduce the general government debt-GDP ratio to 60 per cent, from the current not-so-sustainable 80 per cent levels. The task is cut out, with or without the impact of the Iran conflict and El Niño.