* India cenbank to provide dollars to state-run companies
* Move may help rupee recover from record low of 68.85
* Foreign investors turning heavy sellers of Indian shares
By Neha Dasgupta and Suvashree Dey Choudhury
MUMBAI, Aug 28 (Reuters) - India’s central bank will provide dollars directly to state oil companies in its latest attempt to shore up a currency that has slumped to a record low, reflecting the stiff economic challenges facing the country in an uncertain global environment.
The Reserve Bank of India announced late on Wednesday a special window “with immediate effect” to sell dollars through a designated bank to Indian Oil Corp Ltd, Hindustan Petroleum Corp, and Bharat Petroleum Corp “until further notice”.
The RBI last opened such a window during the 2008 global financial crisis, although it had been widely expected to re-implement the measures after last month telling oil companies to buy dollars from a single bank.
The steps are the latest in a series of extraordinary measures undertaken by the RBI to combat a currency fall of more than 20 percent this year, by far the biggest decline among the Asian currencies tracked by Reuters.
State-run companies are the biggest source of dollar demand in markets - worth $400 million to $500 million daily - and directing them to a special window is meant to reduce pressure on the rupee, which fell as much as 3.7 percent to an all-time low of 68.85 on Wednesday, recording its biggest one-day fall in 18 years.
Rupees traded in markets outside of India recovered after the measures, with one-month forward contracts dealt at 68.30 from levels of around 70 rupees before the announcement.
“Immediately it should help the spot market and improve sentiment,” said A. Prasanna, an economist at ICICI Securities Primary Dealership in Mumbai.
“But then we have to see how global markets move because some of fall in the last few days is also because of global developments.”
The rupee fell on Wednesday on worries that foreign investors will continue to sell out of a country in the midst of domestic woes and a global environment marked by fears of a possible U.S.-led military strike against Syria and the looming end to the Federal Reserve’s period of cheap money.
Officials familiar with RBI thinking told Reuters the dollar sales for state-run oil companies would be offset by positions in forward markets.
That means that although the RBI would need to dip into its currency reserves, it had the prospect of replenishing the lost dollars at a future date by redeeming the forward contracts from oil companies when the rupee stabilises.
The offsetting positions would essentially make these dollar loans, designed to reduce concerns about reserves that at $279 billion, cover only about seven months of imports.
The action further cements the role the central bank is taking to combat the fall in the rupee, as the government has yet to unveil steps that can convince markets it can stabilise the rupee and attract foreign investment.
India badly needs this capital as it struggles with a record high current account deficit, growing fiscal pressures and an economy growing at the slowest in a decade.
The failure to address India’s economic challenges is becoming an increasing source of tension at a time when rising domestic bond yields threaten to raise borrowing costs across the already slowing economy, while global prices of oil and gold - the country’s two biggest imports - have surged this week.
Foreign investors have sold almost $1 billion of Indian shares in the eight sessions through Tuesday - a worrisome prospect given stocks had been India’s one sturdy source of capital inflows with net purchases so far this year still totalling nearly $12 billion.
India’s main National Stock Exchange index fell as much as 3.2 percent on Wednesday, although suspected buying by state-run insurer Life Insurance Corporation - often the buyer of last resort - led the index to recover by the close.
In bond markets, foreign investors have sold more heavily, with outflows reaching nearly $4.6 billion so far this year.
“If steps are not taken to implement the reforms necessary to tackle the structural issues, the government will be left with the so-called ”3D options“: debt default, devaluation, deflation,” said Angelo Corbetta, head of Asia equity for Pioneer Investments in London.
“In India, devaluation is happening now and deflation could be about to start. The good news is that the debt default is highly unlikely.”
BNP Paribas on Wednesday slashed its economic growth forecast for India for the fiscal year to March 2014 to 3.7 percent from its previous 5.2 percent - the weakest growth since 1991-92 when India buckled under a balance of payments crisis that required a loan from the International Monetary Fund.
“India’s parliament remains toxically dysfunctional with little, if any, business conducted,” BNP said.
“And, with next year’s general election looming ever nearer, the government’s willingness to instigate a politically unpopular fiscal tightening is close to nil.”
The government has tried but failed to provide a coherent response, analysts said.
Its approval of infrastructure projects on Tuesday was trumped by concerns about the fiscal deficit after the lower house of parliament this week approved a 1.35 trillion rupee ($19.6 billion) plan to provide cheap grain to the poor.
India is due to post April-June gross domestic product data on Friday, with analysts estimating the economy grew at an annual rate of 4.7 percent, roughly in line with the previous quarter. It will also post July federal fiscal deficit figures.