Indian Rupee ( INR ) – Three questions ?

This Article was Published in Market Express and Indians in Kuwait

The Indian Rupee (INR) is surprisingly strong proving many analysts wrong. In a world where emerging market currencies experience decline, the INR has been appreciating steadily. From a low of Rs.68.77/USD in Feb 2016, the INR value is now Rs.64.54/USD. In 2017 alone so far, the INR has appreciated by 5%. Three questions emerge in this context:

      1.       Why is INR so strong?

      2.       What is the outlook (medium term and long term)? &

      3.       What should NRI’s do?

Why is INR so strong?

In my view, there are 4 reasons why the INR currency is so strong.

Firstly the Modi factor. A lot of things seem to be just going right for him so far. His government is mid-way into its first five year term and he seems to be having a positive rating until now. The biggest and boldest gamble in the form of demonetization actually won him many praise from the same people that stood in queue to withdraw money from ATM. His recent budget has been well received. The Goods and Services Tax (GST) harmonizing all indirect taxes is a huge step taken with lot of political will. Finally a string of major election successes especially in Uttar Pradesh and other small wins in Delhi civic polls. Low oil price is the cherry in the ice cream. Modi is emerging to be a credible leader due to which economic and business confidence is moving up. There is clearly a Modi wave at play here.

This brings us to the second reason which is foreign fund flows. On the back of Modi wave and in the last one year, the fund flows have jumped sharply. Fund flows can happen either through FDI’s (long-term and stable money) or through FII’s (short-term hot money). In India’s case, it is more of later though FDI’s have also picked up significantly. While in all of 2016, there was a negative flow of Rs14,000 crores (USD 2.17bn), so far during the first five months of 2017, the fund flows totaled Rs.100,000 crores (USD 15.49bn). Due to this the forex reserves at RBI are at an all-time high of USD 370 billion.

Thirdly, the Federal Reserve of US where after 8 to 9 years of ultra-low interest rates close to zero, the arrival of Trump and his policies are expected to reverse that course and increase interest rates. However, due to growth and inflationary concerns that increase is proving to be slow and painful. When interest rates in US do not go up as expected, money starts flowing out of US into other markets in search of yields. India is a sweet beneficiary in this process.

Finally, the Reserve Bank of India (RBI). With the change in leadership from Raghuram Rajan to Urjit Patel, RBI seems to have grown more tolerant towards a strong currency. RBI has decisively kept away from the Open Market Operations (OMO) leaving the rupee to settle down wherever the market forces decide. In the past such sharp appreciation in the Rupee would have forced RBI to intervene to protect the interests of exporters. Not this time around.

What is the outlook for INR?

At the beginning of 2017, almost all major investment banks had a negative call on INR. Year-end predictions for INR ranged from 70.8 (Barclays) to 65.5 (Mizhou). However, the continued strength of the currency has made many of them revise their forecast which now ranges from 64.5 (MUFG) to 68 (Nomura).

In the short term (meaning second half of 2017), the Rupee will weaken from the current levels if fund flows start to reverse on the back of some bad news on the Indian economy and Modi front coupled with Fed’s resolve to stick to interest rate increases as announced. Both of them look unfeasible as of now. In other words, the near term outlook for Rupee is one of continued strength and can even approach Rs.62/USD.

In the medium to long-term term (beyond 2017), we should be careful in assuming that INR will continue to be strong. Being an emerging market with all attendant problems, the long-term direction of INR is clearly one of weakening and not strengthening. Until and unless the fund flows into India are FDI and not FII, we should be wary of the hot money leaving the country at the blink of an eyelid. Also, the Modi magic will continue only if his administration moves beyond rhetoric and delivers results as promised. Increasing infrastructure, creating jobs and improving ease of doing business can be tough for an economy that languished for so long. Modi will need two or three terms to fulfill the promises not one.

NRI Strategy

The Kuwait Dinar (which is mostly pegged to USD) was quoting at nearly Rs.230/KD during Feb 2016 and is quoting now at Rs.212/KD which is an 8% reduction in value for NRI’s. Obviously the key question in their mind is whether they should wait for the value to rebound or send money now without waiting. Many of the NRI’s have a regular need to send money home. Hence, they will not have the luxury of timing the remittance. However, for those that enjoy this luxury, given the outlook for continued strength of INR for 2017, it may be a good idea to remit now than later. However as they step into 2018, they will have to turn cautious and expect rupee depreciation. 

PS: The author thanks Deepak Radhakrishnan for data assistance

Saudi Arabia and its US dollar peg dilemma

This Article was Published in The National

The fall in oil prices has strained Arabian Gulf countries’ cur­rency policy, and increased the cost of carrying a US dollar peg.

Most GCC countries are pegged to the US dollar to avoid currency fluctuation and eliminate uncertainties in international transactions (Kuwait is pegged to a basket of currencies dominated by the US dollar).

This comes at the expense of monetary policy flexibility. Stable domestic currency and a fixed exchange rate imply that traders do not have to face currency risks, and therefore will be more willing to invest and facilitate trade. Since oil is the chief commodity in the GCC, and the oil price is fixed in dollars, any exchange rate fluctuation could drastically reduce revenue if the currencies were unpegged.

With the US economy expanding, the Federal Reserve has begun hiking interest rates gradually, and plans to achieve a target of 3 per cent by the end of 2018.

While the US is expected to ride a growth wave over the next few years, the GCC economies, especially the oil exporters, are facing contraction because of low oil prices. Declining oil revenue, subdued global growth, liquidity crunch and geo­political issues are some of the challenges facing the region.

These differences are starker in countries such as Saudi Arabia, the world’s largest oil producer and exporter, where more than 73 per cent of government revenues come from the hydrocarbon sector, according to the Institute of International Finance industry group.

In such a scenario, Saudi Arabia can either follow the monetary policy direction set by the US or deviate from it.

If it opts for the former, the kingdom maintains the peg but sacrifices its growth, as it will tighten monetary conditions during a period of low growth. According to the kingdom’s central bank, the Saudi Arabian Monetary Agency (Sama), a 100 basis point increase in the Saudi Interbank Offered Rate (Sibor) leads to a decline of 90 basis points in GDP in the subsequent quarter and 95 basis points in the quarter after that.

If it opts for the latter, then there will be a gap in interest rates between the US and Saudi Arabia, leading to arbitrage opportunities. To counter this, Sama will have to buy Saudi ­riyals in the open market by selling US dollars from its reserves. And as the Fed increases the interest rate, Sama has to keep depleting its forex reserves until it runs out of dollars. Hence there is a cost involved with ­either choice.

The oil price fall since mid-2014, has reduced the kingdom’s revenue, incurring a deficit of $98bn in 2015, and it is estimating a further $87bn deficit in 2016. The Saudi government had funded this deficit by drawing down its central bank deposits, reducing its forex reserves to $602bn; a drop of $132bn, in the year to this January.

During the last Fed hike, Saudi Arabia, along with ­other GCC countries, raised its interest rates tracking the US monetary policy. According to Moody’s, the kingdom has large foreign currency reserves that provide ample room to maintain the pegged exchange rate regime for several years, even in an adverse oil price scenario. At present, Sama holds about 80 per cent of its investments in US Treasury bills.

While this should have been a clear indication of Sama’s dir­ection, early this year the forwards market for the Saudi riyal sprang to life with speculation that the kingdom could be forced to abandon its three- decade peg to the US dollar. The market expected a 12-month forward exchange rate of 3.85 riyals to the dollar, a 2.7 per cent devaluation from the 3.75 level that has, in essence, held since 1986.

Sama doused the speculation by reiterating that it will continue to stick with its currency peg, and ordered banks in the kingdom to stop offering options contracts on riyal forwards to their clients.

Other GCC countries with sufficient SWF assets and central bank reserves, such as Kuwait, Qatar and the UAE, could also maintain the peg with little difficulty.

However, Oman and Bahrain do not enjoy this luxury, and could potentially run out of reserves in less than three years. Both these countries have resorted to issuing debt to extend the longevity of their reserves.

For Saudi Arabia, speculation about the possibility of depegging its currency from the US dollar may have been premature, but it has provided an opportunity to analyse the costs incurred by the kingdom in maintaining the peg, and whether an alternative exists to the current scenario. While the low oil price does not seem to have affected the peg much, thanks to the presence of ample forex reserves, it could have severe repercussions in the future, if the low prices persist.

Looking ahead, cost benefit analysis, stress and scenario testing are a must to gauge the extent to which the status quo is preferable. While the advantages of maintaining the peg are manifold, so are the costs. Ergo, Saudi must also chart out a road map and prepare for a time where depegging from the US dollar is a preferable option to continuing with an expensive peg.

Four Insights To Reduce GCC Remittances

This Article was published in Arab Times, Al Qabas, Khaleej Times, Arab News, Financial Express, All Pinoy News, Daily Star, The Peninsula, The Sen Live, Gulf News, Egypt Independent, AME Info, Economic Times; Gulf News

During 2014, GCC countries experienced an outflow of over $100 billion in the form of remittances from expatriates that work in the region. The amount is an estimated 6.2% of GDP, a significant cost compared to the United States (0.7% of GDP) or the United Kingdom (0.8% of GDP). The figure was roughly $50 billion in 2010, implying steady and strong growth in remittances.

S.No	Net Outflow  (2014-USD Billion)	Country	GDP  (USD Billion 2014)	Net Outflow as % of GDP
1	124	United States	17,418	0.7%
2	44	Saudi Arabia	752	5.9%
3	29	United Arab Emirates	401	7.3%
4	23	United Kingdom	2,945	0.8%
5	21	Canada	1,788	1.2%
6	16	Hong Kong SAR, China	289	5.8%
7	14	Russian Federation	1,857	0.8%
8	13	Australia	1,444	0.9%
9	12	Kuwait	172	6.9%
10	9.5	Qatar	210	4.5%
Source: World Bank, IMF

There are several factors that contribute to this remittance pattern, as described below:

Home Bias: The majority of Gulf expatriates originate from India, Egypt, Philippines, Bangladesh, Pakistan, Indonesia, Sri Lanka, and Yemen. These countries have a large diaspora population living and earning income off-shore, most often in low paid jobs that require them to leave their families behind in order to save money and support them.

Closed Market: GCC countries have restrictions on what foreigners can own and invest in, which crowds out investment opportunities for expatriates. While some markets such as Dubai have opened up for foreigners, most of them are still out of bounds.

Absence of Tax: GCC countries charge no income tax on salaries paid to expatriates, which is a huge factor that attracts expatriates to opportunities here. However, the model that other countries follow (like the US or the UK), where the local population is taxed as well as provided with social security, actually increases the “engagement quotient” and motivates them to invest in local markets. The required tax also reduces the savings pot, and thus the money available to remit. Therefore, the absence of tax on income acts as a huge attraction towards remittance in the GCC.

Strict Labor Laws: In the GCC, expatriates are able to legally work for a significant period of time, but cannot claim citizenship. As opposed to the US and UK where the possibility of obtaining citizenship is high, the lack of securing citizenship for expatriates in the GCC encourages them to concentrate their investments back home.

Remittances represent a huge lost opportunity for the GCC countries. While GCC countries enjoy high liquidity, attributable to oil revenues, this state of oil dependency is neither assured nor desirable.

I believe the following are ways in which the GCC can curb the growth and outflow of remittances:

Create Jobs/Reduce Unemployment: The GCC is highly dependent on an expatriate labor force, primarily due to the economy size (requiring large scale labor) and a skill shortage among nationals. The expatriate population comprises 49% of the total population in the GCC; additionally, nationals are highly concentrated in the public sector, often as a result of a wealth distribution process rather than actual job needs. Therefore, there is genuine need to create jobs and enable the nationals to secure and retain those positions. This will reduce local unemployment and shift the balance away from expats in the long term, which may then reduce the remittance flow impact.

Incentivize Domestic Investments: GCC countries can incentivize local investments for expats by launching specialized products that cater to their needs and preferences. This will allow the region to tap into the 25 million expats that reside in the region and maximize investment potential.

Open the Markets: GCC countries can start opening up their markets to foreigners, especially expats. Real estate is a great example of an untapped opportunity. Investment by expatriates should be differentiated from foreign investment, as the former provides a more stable source of investment given the length of time they spend in the region. The toughest obstacle would be reaching out to low-wage workers, who constitute the bulk of remittance. An employer engagement strategy (similar to 401k) can be implemented to tap into this segment.

Improving Hard and Soft Infrastructure: The GCC should strive to improve their infrastructure, including  airports, roads, and railways to consistently provide state-of-art lifestyle avenues. This can attract new expat groups that view infrastructure sophistication as important criteria. Areas like healthcare and education should be elevated to best in class, so that expats are motivated to bring and live with their families.

In conclusion, remittances offer a low hanging fruit to GCC governments to implement strategies that can stem and reverse the flow. It is in the long-term interest of GCC countries to reduce at least some of them through proper incentives and investment opportunities.

The Mega Rupee Strength!

During the last 15 months, Euro fell by nearly 25%, Brazilian Real by 30%, Russian Ruble by 50% and Canadian dollar by 18% all against the USD. The INR is down only by 2%!

My previous article on Indian rupee was written during August 2013 titled “The Mega Rupee Slide” when Indian Rupee (INR) was sliding down as if there was no tomorrow. The question back then was, how low the INR will go and how can this be stopped.

Within two years, that question is now flipped over its face. This time around, the motivation to look at INR was for the opposite reason. When almost all global currencies are sliding down against US Dollar (as if there is no tomorrow!), INR is holding up quite well.

This indeed is a very strange situation for an emerging market like India. Can this hold up or Is this just a calm before the storm? This question is important for CFO’s, Foreign Investors, Importers, Exporters and finally NRI’s.

Depreciation Relative to USD	2014	2015-YTD (18th Mar)
Brazilian Real	-11.1%	-18.4%
Euro	-12.0%	-12.4%
Canadian Dollar	-8.6%	-9.3%
Australian Dollar	-8.4%	-7.1%
South African Rand	-9.7%	-6.6%
Indonesian Rupiah	-1.8%	-6.0%
Malaysian Ringgit	-6.2%	-5.7%
Russian Ruble	-43.3%	-5.4%
Singapore Dollar	-4.7%	-4.7%
Mexican Peso	-11.6%	-4.2%
Korean Won	-4.0%	-3.2%
Japanese Yen	-12.0%	-1.3%
Chinese Yuan	-2.4%	-0.5%
Hong Kong Dollar	0.0%	-0.1%
Thai Baht	-0.7%	0.0%
Taiwanese Dollar	-5.7%	0.2%
Indian Rupee	-2.0%	0.6%

But before we answer that question, let us understand what has caused this rapid USD strength against Euro and other currencies. Euro has plunged by nearly 25% since 2014 beginning from 1.4 to nearly 1. The simple explanation to this unprecedented plunge of Euro is the divergent monetary policy of US and Eurozone. US is now in a tightening mode (means increasing the rates) while Eurozone is now in a loosening mode (means reducing the rates). So, when US rates go up and Eurozone rates fall, the spread widens and therefore causes more capital to flow back to US in search of more yields which then results in currency appreciation.

Why is INR so strong?

There are many reasons, but three stand out:

      1.       “Strong”  and improving Economy

      2.       “Prudent” RBI &

      3.       “Rocking” Capital markets

 “Strong” Economy:

“India’s near-term growth outlook has improved and the balance of risks is now more favorable, helped by increased political certainty, several policy actions, improved business confidence, lower commodity import prices, and reduced external vulnerabilities” IMF, March 2015. That is a neat summary of where India is in terms of its economy.

Economic Indicator	2014/15	Current Assessment	Future Assessment
Real GDP growth (%)	5.6	Rebounding	Positive
Inflation (%)-CPI	6.7%	Reducing	Stable
Current Account Deficit (% to GDP)	-1.8%	Narrowing	Stable
Fiscal Deficit (% to GDP)	-4.4%	Declining	Declining
Forex Reserves ($b)	340	Strong	Strong
Public Debt (% to GDP)	64.3	Moderate	Moderate
Data Source: IMF

India is among very few countries in the world that is expected to clock decent real GDP growth for 2015 and beyond. IMF projects a growth of 5.6% for the current fiscal and 6.3% for the next fiscal, a healthy number indeed. The rebound in growth is happening on the back of improved political climate, lower oil prices, increasing confidence among business and investors, and reduced external vulnerabilities as IMF summarized. However, if you look at the projections for say 2019/20, it still remains only at 6.7%, not the 10% that the media loves to tout all the time. If India’s medium-term prospects were to be improved, we should focus removing supply-side bottlenecks.

The reduction in consumer inflation is commendable and timely. The reducing inflation is credited mainly to lower oil prices though RBI’s relentless pursuit to contain inflation is finally paying off through its monetary policy actions. The government’s effort to contain food inflation is also a key contributor here.

India also suffers from the twin deficit problem i.e., fiscal deficit and Current Account Deficit (or what is popularly called CAD). CAD is now at -1.8% of GDP, far lower than -4.7% witnessed during 2012/13. The improving situation is mainly because our import bills are coming down while exports have picked up. Imports have come down mainly due to lower oil prices as well as fall in gold imports (thanks to higher import duties and administrative measures). India has received an unexpected gift in the form of lower oil prices translating into lower import bill. Oil comprised nearly 40% of our import bill before the oil price collapse and hence it is a great relief to be experiencing a lower oil price. But, we do not know how long this gift will last. Future assessment of CAD is also very stable at -2.5%.

Presently India’s fiscal deficit stands at -4.4% showing a declining trend relative to history. As per IMF, it is further poised to reduce though the task is one of great challenge. The fiscal deficit can be reduced only if we increase the revenues or decrease expenditure or do both. Reducing expenditure will involve overhauling the subsidy regime mainly to stop leakages in food subsidies. Improving revenues will involve tax administration reforms.

Our forex reserves at $340 billion is increasing and provides decent cover for our imports (7 months). The growth in our forex reserves is happening on the back of strong FII inflows and narrowing CAD. This is further augmented by NRI deposits and overseas borrowing by corporates through ECB’s. Indian corporates are highly leveraged and normally unhedge their forex exposure. If you notice carefully, all these sources are short-term and volatile. India should look to building its forex reserves through long-term stable forms like FDI. A good comparison here would be China whose forex reserves are close to $4 trillion dollars mainly built on the back of export surpluses. Due to this, China in fact enjoys a current account surplus.

India’s public debt as a % of GDP is about 65% and is considered moderate compared to other countries. Moreover, our total debt is about 135% of GDP (Government: 66%, Corporates: 45%, Households: 9% & Financial Institutions: 15%). Contrast this with say China at 282% of GDP (Government: 55%, Corporates: 125%, Households: 38%, & Financial Institutions: 65%). China’s total debt has grown four times in the six years since global financial crisis and its debt-to-GDP ratio has doubled between 2007 and 2014 according to an analysis done by C.P. Chandrasekhar and Jayat Ghosh and as published recently in Business line. Even though the aggregate debt level for China is high, its current account surplus can weather any storm, while India does not have that luxury. That said, Indian public debt scenario is highly sustainable with favorable maturity structure, currency composition as well as domestic investor base according to IMF.

 “Prudent” RBI

Raghuram Rajan is arguably one of the deft Central Bank governors in the world today. When the new Modi government took charge, one of the best decisions they made is to retain him as the governor of RBI. RBI’s main mandate is to contain India’s uncontainable inflation and he managed to do that exactly, though with a little bit of help from oil price. However, he did not wait for the “lower inflation” thesis to play out fully before decreasing India’s interest rates. He surprised the market with a 25 basis point cut on March 4. Remember, our interest rates are high in response to high inflation and this has been touted as one reason for economic growth not picking up. In other words, many were blaming Raghuram Rajan as obstructing and delaying India’s economic growth. He surprised many when he made a sudden announcement to increase the rates. It shows his conviction that the reduction in India’s inflation is here to stay.

 “Rocking” Capital Markets

A strong capital market attracts foreign investments which contributes to rupee strength. Indian stock market is one of the best performing stock markets in the world. It netted a return of 30% for 2014 and is up by 3% so far in 2015. Strong capital inflows, optimism about reforms by the new Modi government, proactive RBI and huge expectations of infrastructure spending augurs this strong performance of the stock market. Foreign investors are also eagerly buying Indian debt. As markets perform well, the foreign inflows will tend to appreciate the currency and this can be one reason as well. However, Indian markets are not cheap as measured by price to earnings ratio at 17.8 for MSCI India based on forward earnings, which is nearly 25% higher than the long-term average. Valuation can get affordable only if earnings catches up.

What can spoil the party

Two things can spoil the party in my assessment:

      1.       Global market volatility &

      2.       Anemic credit growth magnifying NPA problem

Global Market Volatility:

Everyone from Raghuram Rajan to Arun Jaitley (India’s Finance Minister) is bracing for the “winter” in global financial markets when US Fed will start raising interest rates after a prolonged period of low interest rates. The question is no longer “if” but when. And the rate rise can start either as early as June or at the worst by the end of the year. When US did a “taper tantrum” last time around in 2013, every emerging market felt the heat including India. This time around this event of rate rise is even more powerful than “taper tantrum”. Given the negative yields in Eurozone, a rate rise in US is definite to pull back capital to US. This means hot money will leave the shores of other markets (especially emerging markets) in search of more yields in US. Indian markets are predominantly served by hot money and hence it may have a chilling effect for sure. Let us hope that the policy normalization is not disorderly and inflicts minimum pain for India.

Anemic Credit Growth

The other major concern is the huge swathe of non-performing loans building up in public sector banks coupled with weak credit growth. Accordingly to IMF, the profitability of public sector banks remains weak, due to lower operating efficiency. Large exposure of these banks to infrastructure has turned their asset quality very poor. Due to this, the capital requirements for public sector banks has increased. Basel 3 adoption also increases this pressure. Weak credit growth (at 10%) may not help matters.

Concluding Thoughts

INR is currently trading at Rs.62/USD. Leading investment banks mostly predict Rupee to continue to be strong in 2015 as we can see in the table. While Nomura call is aggressive at Rs.57.5/$, Goldman Sachs predicts INR to reach Rs.63, not too different from the current levels.

	INR Forecast -2015-per USD
ZyFin Research	58
Bloomberg survey	61
Nomura	57.50
Deutsche Bank	64
BoA Merril Lynch	60
Goldman Sachs	63
Reuters poll	62.50

The rapid rise of US dollar and the concurrent rapid fall of Euro surprised many analysts. However, what is even more surprising is the strength of Indian Rupee. This may well reflect the solid Indian economic story. However, currency is a volatile game and few can predict its movement accurately. Among the key risks discussed, IMF flags a surge in financial market volatility as the highest risk for India in 2015 apart from protracted period of slower growth in advanced economies. Hence, it is quite clear that the storm is coming. The question is how well we can cope with it. When that storm arrives, the Indian Rupee should give up and move down to say 65 or even 70 levels if the Fed monetary policy unwinding is orderly. The role of RBI is to make sure that this downward movement of INR is orderly and does not create panic among market participant. Given Raghuram Rajan’s track record so far, it is quite to be expected that he will manage the process well.