The government was able to wad off fears of a sovereign rating downgrade with the announcement of the diesel price deregulation. The rupee immediately appreciated to a two-week high at 54.30 to a dollar after the government signalled there would be price hikes from time to time. This is expected to help the government contain the subsidy bill at 2 per cent of the gross domestic product (GDP). It is also expected to help the government cap the fiscal deficit at 5.3 per cent of GDP wading away fears of any downgrade in the country rating.

Abheek Barua, chief economist, HDFC Bank, said, “The fears of a rating downgrade are certainly more remote as the government’s fiscal consolidation roadmad of containing fiscal deficit at 4.8 per cent of GDP in the long term is more credible. It is a radical step and we will have to watch for the operational details. The exchange rate is the first to reflect this confidence that is why the rupee immediately appreciated. It will certainly do away with the chronic underrecoveries of the oil companies.”

The rupee went down to 54.77 to a dollar and then appreciated to 54.22 before closing the day’s trade at 54.30. The exchange rate has been heavily dependent on the capital flows just like the current account deficit. When the inflow of dollars are strong, the rupee appreciates and vice versa as the Reserve Bank of India (RBI) does not target a exchange rate and intervenes in the forex market only to check the rupee volatility.

Abhishek Goenka, founder and CEO, India Forex Advisors, said, “The rupee was seen trading close to its two-week high against the US dollar after the government announced the deregulation of the diesel prices. This signals that there would be regular increase in the diesel prices. This will put pressure on the inflation, which is still above the comfort levels. Looking at the monetary policy on January 29, it would be difficult for RBI to take a call on rate cut as it would be difficult to tame the rising inflation.”

Higher fiscal deficit and lower growth along with high inflation had forced rating agencies to threaten to junk India’s sovereign rating. According to Moody’s rating, India rating is at Baaa3, one notch above junk status.

According to data on India’s balance of payments (BoP) for the second quarter (July-September) released by RBI in December, the current-account deficit widened to a record high of $22.3 billion, which was 5.4 per cent of GDP, from $16.4 billion in the April-June period despite a surge in foreign investment and government’s measures to curb expenditure.

DK Joshi, chief economist at rating agency Crisil, said, “Deregulation of diesel will have significant fiscal benefits for the country. The exchange rate is depended on capital flows and if the macro-economic conditions are strong, foreign investors will start investing in India.”

manjuab@mydigitalfc.com