India restricts foreign-exchange outflows to stem rupee drop

India announced restrictions on foreign-currency outflows by local companies and individuals after measures to contain a record current-account deficit and attract overseas investors failed to steady the rupee.

The Reserve Bank of India reduced the amount that companies can invest overseas without seeking approval to 100% of their net worth from 400%, according to an e-mailed statement today. Residents can remit $75,000 in each financial year, from a previous limit of $200,000. The rupee erased losses in the offshore market after the announcement.

The restrictions follow the central bank’s moves to tighten cash supply and the government’s attempts to rein in imports by raising gold tariffs. Steadying the rupee is the top priority for monetary policy, the monetary authority said on July 29. The latest steps reflect a shift to “Plan B,” addressing the capital account after trying to contain the current account, according to UBS AG.

“The minute you restrict outflows, people will start legitimately speaking in terms of capital controls, although these are only on locals and not on foreign investors,” Bhanu Baweja, the global head of emerging market cross asset strategy at UBS, said in a phone interview from London today. “I don’t think this fixes India’s problem, at best it restricts about $5 billion of flows annually, which doesn’t make a dent on the big picture.”

‘Impossible Trilemma’

One-month offshore non-deliverable rupee forwards rose 0.1% 61.88 per dollar after today’s announcement. Forwards are agreements to buy or sell assets at a set price and date. Non-deliverable contracts are settled in dollars. The Bank of New York Mellon India ADR Index was 0.4% lower at 10:05 a.m. in New York.

The imposition of capital controls is one facet of the “impossible trinity trilemma” that RBI Governor Duvvuri Subbarao said the central bank is facing. The economics theory argues that it isn’t possible to have free movement of capital, a fixed exchange rate and an independent monetary policy simultaneously.

The rupee plunged to an unprecedented 61.8050 per dollar on Aug. 6, as foreign investors pulled about $10 billion from Indian bonds on concern the U.S. will pare stimulus. The currency fell even after the central bank raised two interest rates July 15 and restricted bank’s access to cash through its daily repurchase auctions.

‘Magic Wand’

Raghuram Rajan, the University of Chicago economist credited with predicting the 2008 financial crisis, will take charge of the Reserve Bank next month after Subbarao’s term ends Sept. 4. There’s no “magic wand” to fix India’s problems, he said on his appointment Aug. 6., while adding the RBI and the government will deal with the challenges.

A weaker currency stokes inflation and makes imports more expensive for a country that has a record current-account deficit and is growing at the slowest pace in a decade. India imports about 80% of its oil and is the world’s largest consumer of gold, almost all of which is mined abroad.

The shortfall in the broadest measure of trade widened to 4.8% of gross domestic product in the year ended March 31. The government will narrow the gap to 3.7% of GDP, or $70 billion, this financial year, Chidambaram told parliament in New Delhi today.

The measures “are unlikely to have a meaningful impact on the currency,” Aneesh Srivastava, chief investment officer at IDBI Federal Life Insurance, said in a phone interview. “For a long-term impact we need to increase the attractiveness of India as an investment destination.”

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