By Abhishek Vishnoi and Swati Bhat
MUMBAI (Reuters) - The rupee rallied and shares surged on Thursday after India's new central bank chief unveiled measures to support the ailing currency, providing a shot of confidence for investors unnerved by the country's worst economic crisis in two decades.
But amid the euphoria over Reserve Bank of India Governor Raghuram Rajan's energetic Wednesday debut, investors warned he cannot by himself repair an economy mired by slowing growth and a record high current account deficit that has helped fuel a drop in the rupee of as much as 20 percent this year.
Rajan faces pressure from investors to roll back the central bank's controversial steps to defend the rupee by draining cash from the market and raising short-term interest rates at a time when investors are clamoring for ways to boost growth.
The government has struggled to push through politically tough reforms needed to fix the economy, and elections due by next May raise the prospect of expensive populist spending that could threaten the country's sovereign credit rating, which is one notch above junk status.
Finance Minister P. Chidambaram said again that New Delhi would stick to its fiscal deficit target for this fiscal year, while repeating his oft-stated view that the rupee had fallen too far and was due to recover.
"This is a year of fiscal consolidation," he told parliament. "I have repeatedly said that the 4.8 percent (of GDP), which we have estimated will be the fiscal deficit, is a red line. The red line will not be crossed."
On Thursday, however, skepticism was trumped by euphoria over Rajan, a prominent former chief economist at the International Monetary Fund, who unexpectedly unveiled a flurry of proposals in his first day at the helm of the central bank.
The rupee rose as much as 2.3 percent to 65.53 per dollar, well off the record low 68.85 hit on August 28, when it was down more than 23 percent from its 2013 peak. It ended trade at 66.01, compared to its close of 67.0650 on Monday.
The main NSE <.NSEI> share index rose as much as 3.3 percent, propelled by lenders such as HDFC Bank <HDBK.NS>, which surged after new steps outlined by Rajan that included increasing overseas borrowing limits for banks.
The new measures to prop up the rupee included providing exporters and importers with more flexibility in hedging their forward currency contracts, as trading firms had long complained about regulation that left them unable to quickly cope with rapid currency movements.
Rajan also announced plans to offer fore swap lines at below-market rates for banks raising deposits from Indians abroad. Bankers estimate those measures could attract about $15 billion in additional funds over the next three months.
"Rajan means business, but most of his measures are just statements of intent, especially in the light of government finances being so precarious," said G. Chokkalingam, chief investment officer at Centrum Wealth Management.
Rajan faces difficult decisions ahead, including navigating uncertain global conditions marked by rising military tension over Syria, which is pushing up India's oil import bill, and the prospect of an end to U.S. monetary stimulus.
The RBI has been the main line of defense against the rupee so far, with previous Governor Duvvuri Subbarao having opted to sacrifice near-term economic growth, putting interest rate cuts on hold in a quest for financial stability.
With economic growth remaining weak, investors are already clamoring for the RBI to change course.
"I will not give in to the personality and sentiment. I will look at data," said Phani Sekhar, a fund Manager at Angel Broking in Mumbai.
"The governor has no control on fiscal policy so what do you expect the RBI to do? If Rajan continues focusing on inflation, his newly found fan club will vanish sooner than later."
IN SEARCH OF REFORMS
Asia's third-largest economy is suffering from sluggish investment as well as slowdowns in the manufacturing and services sectors.
Investors have expressed little faith that New Delhi can push through substantial reforms, such as a hike in subsidized fuel prices, that could help revive confidence in the economy.
Measures the government has passed, including curbs to gold imports and opening up sectors for foreign investment, have been dismissed as too small or not helpful enough by markets.
India's lower house of parliament approved changes aimed at luring foreign asset managers to run retirement funds on Wednesday, but foreign firms say the new law is unlikely to immediately trigger a flood of investment.
Economists say the government will ultimately need to step in to provide more long-lasting support for the rupee.
"India's myriad cyclical and structural impediments will continue to hold back the economy for the time being, and risks of a deeper crisis are non-trivial," Deutsche Bank wrote.
"But (Wednesday's) statement shows a fresh and cohesive vision of monetary and financial sector policy from a newly appointed central bank governor can shine a much-needed light on India's promise and potential."
(Writing by Rafael Nam; Additional reporting by Suvashree Dey Chodhury, Sumeet Chatterjee, and Subhadip Sircar; Editing by Tony Munroe & Kim Coghill)