However, New Delhi is reluctant to issue an overseas bond to draw fresh dollars given the costs and risks of such a move.
The rupee touched an all-time low of 56.22 to the dollar on Wednesday, its sixth straight record, despite the Reserve Bank of India's move late on Monday to limit volatility by cracking down on speculation or arbitrage in the rupee futures and forwards markets. It ended higher at 55.995 per dollar.
While the RBI has been stepping into the market in recent weeks to defend the rupee by selling dollars, its capacity to intervene is limited. A series of recent administrative measures to prop up the rupee have also had only a modest impact.
“The floating of a sovereign bond should be considered as one of the last weapons to be used if the situation really goes out of control, as the government would have to bear its cost,” said a Finance Ministry official who declined to be identified.
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Traders and market watchers have talked increasingly in recent days of the possibility of a sovereign bond issue in order to slow the decline in the currency, which is the worst performer this year in emerging Asia, shedding some 3.4 per cent against the dollar.
Another option would be to issue a bond exclusively for non-resident Indians through State Bank of India. It issued similar bonds in 1998 and 2000.
“With markets testing RBI tolerance for rupee depreciation, the authorities might need to tap other measures in the toolkit to stem the unit's fall. Sovereign bond issuance is one of them, which will beef up the country's dollar reserves,” said Radhika Rao, an economist at Forecast Pte in Singapore.
“It would perhaps be better to expedite such an issuance, as the economy still enjoys investment grade, and thereby reach a wider investment community,” she said.
India's sovereign rating is at the lowest investment grade level, although Standard & Poor's recently surprised the market by lowering its outlook to negative from stable.
The rupee has been battered by India's wide current account and fiscal deficits, sluggish economic policymaking and global risk aversion fuelled by the euro zone crisis. Economists and traders have long called on India to do much more to improve its fiscal position and attract investment.
Finance Ministry officials, noting that India has limited space to intervene in the market, said the government is reluctant to issue overseas bonds and said some of the burden of attracting dollars can be borne instead by banks.
“The banks can be asked to further raise interest rates on non-resident Indians' deposits to attract dollars,” said another finance ministry source, who declined to be identified due to the sensitivity of the matter.
Another possibility for reducing rupee volatility would be for the RBI to sell dollars directly to state-run oil companies, which import 80 per cent of the country's petroleum, a move that Nomura said would boost the rupee, although it would also deplete India's dollar reserves.
P.K. Goel, head of finance at Indian Oil, said the RBI has been asking about its dollar demand but said there had been no indication from the RBI as to whether it would provide dollars to refiners at a better rate than it gets in the market.
The government could also further relax limits on foreign inflows into corporate and government bonds if needed, the second Finance Ministry source said.
Thus far, the RBI has taken various administrative steps and sold dollars from its limited stockpile in order to slow the decline in the rupee, which is down nearly 14 percent since a February peak.
RBI Deputy Governor Subir Gokarn said late on Monday that it would continue to take measures to stabilise the rupee but said the currency's direction ultimately depends on capital flows.
RBI officials, declining to be named, have said weakness is likely to persist.
On Tuesday, Finance Minister Pranab Mukherjee also expressed resignation about the rupee's near-term prospects.
“Whatever is happening to rupee is due to market forces and market forces are uncertain. There is a volatility,” he told reporters. “We are taking a series of steps, but it is a market related activity,” he said, referring to the rupee's weakness.
India does not have any outstanding overseas sovereign bonds. Issuing one would attract dollars but would also add to the government's debt burden and expose it to currency risk.
Investors would be likely to demand an attractive interest rate given negative market sentiment towards India, which could prove fiscally and politically unpalatable to a government already weakened by a series of scandals.
Copyright @ Thomson Reuters 2012