Finance minister Chidambaram tried to talk up the rupee on Friday after it plumbed another record low on concerns the central bank's latest measures to defend the currency could be a step towards outright capital controls.
Traders said the Reserve Bank of India (RBI) was forced to step in to prop up the rupee as measures from the central bank late on Wednesday restricting how much Indian citizens and companies can invest abroad were seen as yet another roll of the dice that is undermining investor confidence.
Concerns that policymakers were losing control over the currency spread to the stock market, which dropped 4 per cent, its biggest one-day decline in nearly two years.
Chidambaram told reporters that global developments, including the dollar spike after U.S. jobless claims data on Thursday, were behind the rupee falls.
"I have no doubt in my mind when calm is restored in the market, people will begin to understand that Indian market indicators must basically reflect Indian market conditions," Chidambaram said.
"I think this is time for calm. This is time for reflection."
Indian policymakers have cobbled together a slew of steps over the past month in a bid to halt the rupee's slide, including the central bank's extraordinary steps on July 15 to drain cash from the system and raise short-term interest rates in an economy already growing at a decade low.
Yet none of the steps or the rhetoric so far have convinced investors that India can attract overseas investments, which is seen as essential in narrowing a record high current account deficit that is the biggest source of the rupee weakness.
The approach is instead beginning to test the patience of foreign investors, just when emerging markets such as India are seen as particularly vulnerable to reduced cash inflows once the expected tapering of monetary stimulus by the U.S. Federal Reserve begins.
"They're coming across as a bit panicky. That's what is damaging sentiment for investors," said Jonathan Schiessl, a fund manager at Ashburton Investments in Jersey, referring to the RBI's actions to defend the rupee.
"Unless things improve, we will probably in all likelihood be withdrawing some weightings from our India positions."
The partially convertible rupee fell to an all-time low of 62.03 to the dollar as trading began on Friday. It ended the session at 61.65, weaker than Wednesday's close of 61.43/44. Markets were closed on Thursday for a holiday.
Slip sliding away
The prospect of the Fed stimulus rollback looms over India as the country struggles with a current account deficit that hit a record high of 4.8 per cent of gross domestic product while its economic growth has slowed to a decade low of 5 per cent.
Foreign investors have already sold a net $11.6 billion of Indian debt and equities since late May, sparking fears of further outflows.
India's benchmark 10-year bond yields surged to their highest since May 2012 on Friday.
"India is losing control over the currency and you are starting to see the weakness transmitting to stock markets. There could be a self-perpetuating cycle where currency weakness flushes out equity investors and that takes the rupee weaker still," said UBS strategist Manik Narain in London.
The RBI's restrictions on capital outflows are likely to delay overseas acquisitions and investment plans by India Inc at a time when many companies are scouting markets abroad to beat the domestic economic slowdown.
Yet the biggest fear is that the RBI's action could be the start of a far stronger move to restrain capital.
"The steps taken so far only target residents, but if this raises expectations that they could potentially resort to capital controls targeted at non-residents, that could have adverse near-term implications for capital flows," HSBC's Chief economist for India and ASEAN Leif Eskesen said.
"It will, therefore, be critical to tread very carefully when it comes to capital controls, to anchor expectations, and also not use it as a substitute for more appropriate and effective measures," Eskesen said in a note to clients.
As policymakers struggle to stem the rupee's falls, markets expect more weakness ahead. Overseas investors betting via one-month offshore non-deliverable forwards quoted the rupee trading at 62.46, while onshore bets see it 62.35.
A Reuters poll on Thursday showed short positions in the rupee had hit the highest in two months.
None of the measures unveiled by India so far have given markets assurance that the country can attract foreign flows in an increasingly difficult global environment, analysts said.
India last month unveiled plans to further ease restrictions on foreign direct investment (FDI) but previous measures have had mixed results. FDI fell to $36.9 billion in the fiscal year ending in March from $46.6 billion the previous year.
This week it announced measures to attract near-term capital inflows, including from state-run companies selling debt abroad.
Yet doing so could prove hard without major confidence-inspiring reforms, especially as RBI measures last month to drain cash raise the prospect that borrowing costs will rise.
"We remain underweight on Indian credits as the current spreads do not offer enough compensation in our view," said Arthur Lau, head of fixed income for Asia ex-Japan for Pinebridge Investments in Hong Kong.
Sensex slumps 770 points on capital control, U.S. stimulus fears
The Nifty slumped 4 per cent on Friday, marking its biggest daily drop in almost two years, as blue chips including HDFC Bank were hit across the board on fears U.S. stimulus tapering would trigger foreign selling and as the rupee hit a record low.
The Reserve Bank of India's measures late on Wednesday to restrict how much its citizens and companies can invest abroad also raised fears of outright capital controls that would further undermine the confidence of foreign investors, hitting the rupee.
The volatility index which measures the cost of protection via options and is seen by some investors as a "fear" gauge gained 26.4 per cent, marking its biggest single day per centage gain since June 17, 2009.
The outlook remains weak as Indian shares marked their fourth consecutive weekly fall, totalling a decline of 7.7 per cent, as the rupee has tumbled despite various measures undertaken to prop up the currency.
"FIIs (foreign institutional investors) may pull out further on continued concerns over Fed's potential tapering and as the rupee continues to make record lows," said Sachin Shah, a fund manager at Emkay Investment Managers Ltd.
Although valuation have started looking attractive, Shah added.
The Sensex plunged 3.97 per cent, or 769.41 points, to end at 18,598.18, also falling 1 per cent for the week, marking its fourth consecutive weekly fall.
The Nifty dived 4.08 per cent, or 234.45 points, to end at 5,507.85, marking its biggest single daily fall since September 22, 2011.
The index closed below the psychologically important 5,600 level after falling 1.03 per cent for the week.
Blue chips fell across the board. HDFC Bank slipped 5.4 per cent, while Reliance Industries tumbled 4.4 per cent.
Axis Bank slumped 8.8 per cent after MSCI said it would exclude the bank from its standard and large-cap indexes.
Axis shares also come under pressure after the Reserve Bank of India said on Wednesday overseas investors will not be allowed to purchase additional shares given the foreign shareholding limit has been breached.
Among other stocks consumer goods shares were hit: ITC fell 4.3 per cent while Hindustan Unilever ended 2.9 per cent down.
Tata Motors fell 1.6 per cent as Wednesday's 9.7 per cent gains on unit Jaguar Land Rover July sales were seen as overdone.
Titan Industries shares slumped 12.1 per cent after the RBI banned imports of gold coins and medallions and required domestic buyers to pay cash for the yellow metal, among other measures.
Analysts said this would increase interest costs and hurt margins for players like Titan.
However among stocks that gained, Financial Technologies (India) ended up 2.6 per cent after unit National Spot Exchange Ltd on Wednesday said it would settle 55.37 billion rupees worth of outstanding forward contracts over seven months, after earlier suspending trading in these securities.