Indian rupee hits record low; capital control fears grow

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The Indian rupee fell to a record low on Friday as central bank measures to tighten capital outflows and curb gold imports were seen as unlikely to prop up the currency and could even spark further selling if they spook foreign investors.

The rupee hit an all-time low of 62.03 to the dollar, breaching its previous record low of 61.80 hit on Aug. 6.

India late on Wednesday restricted how much its citizens and companies can invest abroad to reduce pressure on the rupee, while targeting the current account deficit by banning imports of gold coins and medallions among other measures.

(Read more: Is this currency about to follow the rupee's crash course?)

The efficacy of the steps remains in doubt, given outflows have already been declining this year and that they ultimately do not address the need to attract overseas investments to narrow a current account deficit that hit a record 4.8 percent of gross domestic product in the year ended in March.

Instead, traders fear the capital restrictions could adversely impact company profits and could lead to stronger capital restrictions that would scare off foreign investors at a time when the expected tapering of U.S. monetary stimulus is already creating uncertainty in emerging markets.

"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 LeifEskesen said.

(Read more: India unveils gold duties in piecemeal approach to defend rupee)

"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.

The partially convertible rupee was trading at 61.88 per dollar at 1031 India time (0501 GMT), weaker than its Wednesday's close of 61.43/44.

One-month offshore non-deliverable forwards were quoted at 62.46, weaker than the onshore one-month forward of 62.35.

Indian financial markets were closed on Thursday for a national holiday.

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A Reuters poll issued on Thursday showed short positions in the Indian rupee have hit the highest in two months amid sustained doubts over policy makers' ability to stabilise the currency.

The weakness on Friday also reflected a firmer dollar in Asia amid uncertainty about the U.S. Federal Reserve's stimulus withdrawal after upbeat U.S. jobless claims data on Thursday suggested an early end to the Federal Reserve's asset purchases.

The benchmark 10-year bond yield surged 16 basis points to 8.66 percent from its previous close after U.S. Treasury yields jumped to two-year highs.

Measures to restrict capital outflows come as overseas investments from India had already been on the wane, averaging a monthly $400 million in the first half of the year from $710 million in 2012, according to DBS data.

To prop up the rupee in the near-term,markets would need assurances that India can attract foreign flows in an increasingly difficult global environment.

Foreign investors have sold a net $11.6 billion of Indian debt and equities since late May.

India last month unveiled plans to further ease restrictions on foreign direct investment (FDI) in sectors such as telecoms and defence.

Although the government hopes its latest reforms attract long term capital flows, 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.

The RBI on Wednesday also eased some of the rate limits for deposits targeted at non-resident Indians (NRIs), though that is also seen as unlikely to attract inflows in the near term given that NRI deposits have seen net withdrawals of $1.1 billion in May and June, according to DBS.