India's frequent FX rule changes raise concerns over policy predictability, Allianz exec says

Hedging rule changes may prompt investor caution - Allianz’s Ang Hedging demand may shift offshore, fragmenting markets - Ang RBI may resort to more rate hikes if rupee pressure persists - Ang By Nimesh Vora MUMBAI, Oct 16 (Reuters) — India's frequent foreign-exchange rule changes to shore up the rupee risk undermining policy predictability and fragmenting currency market liquidity, a portfolio manager at Allianz Global Investors said. India's support for the rupee now extends beyond market intervention to measures aimed at influencing hedging.

The Reserve Bank of India, seeking to discourage dollar demand, has made it more expensive for importers to hedge future current-account payments, while leaving exporters unaffected. The central bank has further raised the cost of buying foreign currency for certain transactions for banks and barred companies from rebooking cancelled FX contracts, reinstating a restriction it first introduced in April and later withdrew following feedback from bankers.

"The repeated changes to hedging rules could make foreign investors more cautious around liquidity, hedging efficiency and policy predictability," said Ze Yi Ang, senior portfolio manager at Allianz Global Investors, which manages more than 650 billion euros (about $730 billion) in assets. Legitimate hedging could be delayed, shortened or shifted offshore, leading to segmentation of the onshore and offshore markets, he added. This is already on display with offshore hedging costs having fallen well below onshore levels, an unusual divergence, bankers said. While the RBI's steps are justified to prevent disorderly currency moves, there is a trade-off, Ang said.

"The increasing use of regulatory measures to influence FX market behaviour could reduce onshore liquidity and make investors more cautious about how easily they can manage currency risk," he said. Rate Hikes The Next Defence With FX rules already tightened significantly, the RBI may make interest rates its next line of defence if pressure on the rupee persists, according to Ang. The central bank raised its policy rate by 25 basis points this month, its first hike in nearly four years, and shifted to a calibrated tightening stance, signalling more could follow. A pickup in inflation adds to the case for tighter policy.

Retail inflation accelerated to 5.54% in September from 4.82% in August, its highest level this year and the fourth straight month above the RBI’s 4% target. That gives the central bank a domestic rationale for further hikes, even as currency stability becomes a more pressing consideration, Ang said. "The risks have shifted towards a faster and possibly larger hiking cycle, particularly if (FX) reserve losses remain elevated, inflation continues to surprise on the upside, and the rupee comes under renewed pressure," he said. ($1 = 0.8902 euros) (Reporting by Nimesh Vora; Editing by Jochelle Mendonca) ((nimesh.vora@thomsonreuters.com)