The Indian Rupee (INR) is the worst performing currency in
the world during 2011 (Table-1). At Rs.52/USD it slid by a whopping 17% during
2011 and 6% in November alone. The following questions emerge out of this:
1.
Why did the rupee
depreciate so fast?
2.
What is the further
downside and how low can it go? &
3.
What should be the strategy?
Let me try and answer them one by one:
1. Why did the
Rupee depreciate so fast?
Technically rupee depreciates against the dollar when people
sell rupee and buy dollars. There are four reasons cited for this:
a.
Economy (both global and
domestic) and Trade
b.
Stock Market
c.
RBI &
d.
Corporate Hedge
Economy & Trade:
Indian economy, after growing briskly during the last few
years, is expected to slow down during this year and next. From a growth rate
of close to 9%, the forecast now is about 7 to 7.5%. This is on the back of
global slowdown and other associated problems.
Indian economy’s deficit is spiraling out of control. Both
the fiscal deficit and current account deficit are headed for further
deterioration during this year and next. While the fiscal deficit (not counting
the states) is headed towards 4.5%, the current account deficit is projected at
$44 billion or 2.6% of GDP. This is in sharp contrast to China which is
expected to post a Current Account surplus of $305 billion or 5.2% of its GDP. The current account deficit is triggered primarily
by trade deficit (Export-Import). Not only our imports exceed exports, but even
within the imports the dominance is by oil and gold imports, something very
difficult to control.
While this is the domestic story, the global events are not
too encouraging either. Both the US and Europe are struggling with one crisis
after another with no solution in sight. The US lawmakers are finding it
difficult to arrive at a consensus on deficit reduction. Any stalemate on this
will make investors exit high yielding emerging market assets in favor of US
Treasuries which means buying more dollars. This is technically the reason why
USD is appreciating even though USA is in deep mess.
Stock Market:
The Indian stock market is down by 20% for the year on the
back of poor global market sentiments and sagging earnings. However, the key to
stock market performance has been the liquidity which to a great extent depends
on Foreign Institutional Investors (FII’s). For FII’s, their overall return is
a function of both stock market performance and currency performance. In other
words, a great scenario for them would be a good stock market and appreciating
currency. On the flip side, a lousy combination would be to have a negative
stock market and depreciating currency. For eg. If stock market slides by say
25% and currency depreciates by say 10%, then the total loss is 35% in dollar
terms which is a double whammy.
FII’s have been significantly ramping up their inflows in
the Indian stock market during the last several years (Table 2). However, trouble in US and more recently in
Europe has increased their risk aversion and this resulted in sharp drop in
foreign inflows in Indian stock market during 2011. This reduces demand for
rupee leading to its depreciation.
RBI:
Reserve Bank of India is tasked with ensuring the financial
stability of the economy and hence is the sole inventor of the monetary policy.
In the past, when currency encountered volatility or undue fluctuations, RBI
used its foreign exchange reserves to intervene in the market (through purchase
or sale of dollars) and thereby reduce the volatility of the currency. However,
this time around, they raised their hand and declared openly their intention
not to interfere in preventing the rupee slide.
In a way such a clear cut communication is good as at least
market players can guesstimate the likely outcome, but such a declaration is
also an open invitation for speculators to short INR. More importantly let us
understand as to why RBI has adopted such a “no intervention” policy. It is a
strategic choice. If RBI thinks that the problem is temporary and hence any
small intervention can bring the equilibrium back, then it is worth taking the
risk. However my assessment as to what RBI thinks on this subject is that it
expects the global economy to further deteriorate and hence it may not want to
waste the precious foreign exchange reserves ahead of time only to be a lame
watcher towards the later part of the episode.
For 2010/11, the foreign exchange reserves totaled $282 billion and
represented roughly 7 months of imports. For China, it amounted to $2,884
billion and represented 21 months of import cover, a far comfortable situation
to be in. Hence, we can clearly understand the predicament of RBI to intervene.
Corporate Hedge:
Many CFO’s turned quite easy and relaxed due to continued
rupee strength during the last few years. They expected this to continue
forever and hence did not bother to hedge their currency risk exposures,
especially if you are an importer. However, all of them were caught off guard
by the turn of events due to which they ran for cover to hedge their exposure
which led to intense buying of dollars leading to its appreciation. On the
other hand, exporters are still watching and waiting for even more fall so that
they can reap a windfall.
2. What is the
further downside and how low can it go?
The rupee has clearly caught everyone by surprise by its
fast slide. When you look at comparative numbers for other emerging markets and
developed markets (Table 1), this slide is indeed very sharp and unexpected.
Research agencies and investment banks now say that if RBI does not step in,
then Rupee can further slide to Rs. 55 or even Rs. 57 by the end of the year.
However, to get a long-term trend, let us revisit the four points explained
above and see how they will evolve as we move forward:
Analysis
|
Assessment
|
|
Economy
|
It is very clear that global growth will struggle for the next few
years. However, India is not an export-dependent economy like China. It is a consumption-led
economy. Hence, even in this gloomy global scenario, we can expect Indian
economic engine to roar at 7% minimum. Hence, we are on strong turf on this.
|
POSITIVE
|
The deficit is a long-term problem especially the fiscal deficit. No
matter which government is in place, populist policies will ensure that the
deficit does not come down. However, if they do not go up, then that itself
will be good news. On the other hand, the current account deficit may come
down in the future primarily because of rupee depreciation. Importers will
either reduce their imports or hedge while exporters will ramp up exports to
take the best advantage of a weak rupee. This may turn the trade deficit to
more favorable terms which will in turn reign in the CA deficit.
|
NEUTRAL
|
|
Stock Market
|
FII investments will not come back unless some calmness returns to US
and Europe financial markets. And without their strong inflows, there is no
way stock markets are going to get their insulin. However, we should also not
forget the fact that there are very few investing opportunities around in the
world today. Hence, at the instance of first signs of stability in the global
economies, liquidity will start flowing once again to emerging stock markets
especially India. This may not happen in 2012 but will eventually happen in
later years.
|
NEUTRAL
|
RBI
|
RBI, with just 7 months of import cover in terms of foreign reserves,
does not have the fire power to prevent a rupee slide. Also, RBI actions are
always short-term and cannot produce long-term directional change to the
fortunes of rupee. Also, the RBI actions of late to control inflation have met
with huge failure raising its credibility and ability to pursue and implement
sound policies.
|
NEGATIVE
|
Corporate Hedge
|
The current slide can be partly attributed to the rush to cover the
exposure. With the erratic behavior of the currency, finance managers and
CFO’s will be wiser to hedge future exposure which may prevent volatility.
Also, the depreciation of rupee will help increase exports which will bring
in the much needed USD.
|
POSITIVE
|
Hence, as we can see, all factors are either neutral or
positive with only RBI being on the negative assessment. This means that there
isn’t more danger on the downside to the rupee.
3. What should
be the strategy?
Currency and interest rates are the hardest thing to
estimate in financial markets. Hence, the best thing would be to hedge and not
try and anticipate currency movements. Having said that, the following could be
done:
If you are a domestic investor, you should focus on export
oriented sectors like IT for investments. They will have a great year ahead.
If you are a non-resident Indian, this probably is the best
time to remit money to India. If you have dollar investments, it will be wise
to exit the position and remit the money back to India.
If you are a corporate in India with significant foreign
exchange exposure (either as importer or exporter), it is time to have some
sound hedge in place as currency volatility is only expected to increase than
decrease.
Table-1: Currency Performance
Currency Against USD
|
Nov-11
|
YTD
|
2010
|
2009
|
2008
|
2007
|
2006
|
BRAZILIAN REAL
|
3.5%
|
9.3%
|
-4.8%
|
-25.2%
|
31%
|
-16.6%
|
-9%
|
RUSSIAN ROUBLE
|
1.2%
|
2.1%
|
0.7%
|
-0.7%
|
24%
|
-6.8%
|
-8%
|
EURO
|
-1.5%
|
0.4%
|
-6.5%
|
3.2%
|
-5%
|
10.9%
|
12%
|
UK £
|
-2.0%
|
-0.2%
|
-3.0%
|
12.3%
|
-28%
|
1.7%
|
14%
|
JAPANESE YEN
|
-1.7%
|
-5.1%
|
-12.9%
|
2.7%
|
-19%
|
-6.2%
|
1%
|
THAI BAHT
|
0.8%
|
3.3%
|
-9.6%
|
-4.1%
|
3%
|
-6.8%
|
-12%
|
PAKISTAN RUPEE
|
1.4%
|
1.9%
|
1.6%
|
6.6%
|
28%
|
1.2%
|
2%
|
INDIAN RUPEE
|
5.9%
|
16.6%
|
-3.9%
|
-4.5%
|
24%
|
-10.9%
|
-2%
|
SINGAPORE $
|
2.1%
|
1.8%
|
-8.8%
|
-2.6%
|
0.09%
|
-6.2%
|
-8%
|
CHINESE RENMINBI
|
0.1%
|
-3.6%
|
-3.3%
|
-0.1%
|
-6%
|
-7.0%
|
-3%
|
Source: Reuters
Note: Positive sign indicates depreciation and vice-versa
Table-2: FII inflows
Rs cr
|
|||
Financial Year
|
Equity
|
Debt
|
Total
|
1992-93
|
-
|
-
|
13.4
|
1993-94
|
-
|
-
|
5126.5
|
1994-95
|
-
|
-
|
4796.3
|
1995-96
|
-
|
-
|
6942
|
1996-97
|
-
|
-
|
8574.5
|
1997-98
|
5267
|
691.1
|
5957.2
|
1998-99
|
-717.2
|
-867
|
-1584
|
1999-00
|
9669.5
|
452.6
|
10122.1
|
2000-01
|
10206.7
|
-273.3
|
9933.4
|
2001-02
|
8072.2
|
690.4
|
8762.6
|
2002-03
|
2527.2
|
162.1
|
2689.3
|
2003-04
|
39959.7
|
5805
|
45764.7
|
2004-05
|
44122.7
|
1758.6
|
45881.3
|
2005-06
|
48800.5
|
-7333.8
|
41466.7
|
2006-07
|
25235.7
|
5604.7
|
30840.4
|
2007-08
|
53403.8
|
12775.3
|
66179.1
|
2008-09
|
-47706.2
|
1895.2
|
-45811
|
2009-10
|
110220.6
|
32437.7
|
142658.3
|
2010-11
|
110120.8
|
36317.3
|
146438.1
|
2011-12 (till Sep30, 2011)
|
2209.3
|
6478.8
|
8688.1
|
Source: SEBI
|
PS: The author thanks Humoud Al-Sabah and Deivanai for data
assistance
