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Rupee vs the Dollar

 

The real challenge for India is its lack of options to stem the free fall of currency
PARVESH SHARMA, MD, PENNANT CAPITAL TRENDS | Issue Dated: September 15, 2013, New Delhi
Tags : US dollar | Indian Rupee | Syria | Military strike | Current Account Deficit | high inflation |
 

In one of the most volatile weeks in the history of Indian currency, rupee slumped to its all-time low of 69.20 against US dollar before recovering sharply to close the week at 65.70. In a perfect storm scenario, non-economic factors like uncertainty over a possible US-led military strike against Syria for allegedly using chemical weapons against its own people coupled with a ballooning Current Account Deficit, high inflation, and sheer economic mismanagement knocked the wind out of rupee. In August itself, the rupee suffered a monstrous fall of almost 10 percent on the closing basis. On intra-day basis, it touched as low as 14 percent before recovering sharply in the last two days on the news that Reserve Bank of India would sell US Dollars from its reserves to major oil companies in order to meet their daily dollar obligations. This sharp correction in the rupee is reminiscent of late 1997 and early 1998 when it plunged by about 10 percent following the Asian financial crisis.

So what is causing this sharp correction in the Indian currency, so vital for our economic health? There are multiple factors at play here but some of the usual suspects are market speculation, high fiscal and current account deficits, high inflation and sheer economic mismanagement.

The biggest concern is of course the current account deficit which for the past couple of years has been above 4 percent of the gross domestic product (GDP) partly due to the fact that we continue to import high levels of commodities like gold and oil. Also, a gradual improvement in U.S. economy would mean U.S. Federal Reserve would slowly exit on its Quantitative Easing (QE) program putting additional pressure on rupee while strengthening the US Dollar. However, a growing US economy will increase demand for our exports, especially in the services sectors, and thereby increasing USD inflows and offsetting the impact of rising USD.

A major concern arising out of falling currency is high inflation. Although the official measure of inflation, i.e. the wholesale price index (WPI), is falling and is now below 5 per cent, it is not an accurate or appropriate measure of inflation, especially given that the retail inflation that is consumer price index is hovering close to 10 per cent.

India’s sovereign credit rating is another major concern. Credit rating agencies have put India on the watch citing poor economic fundamentals, high fiscal and Current Account Deficits and lack of action from the government. A downgrade would push India’s rating to below investment grade, which may force many investors to sell Indian securities. The sharp depreciation of rupee, along with measures taken by the Indian government and Reserve Bank of India to curb import and improve export and attract greater remittances, may actually help the Current Account Deficit, which is the difference between the outflow and the inflow of foreign currency this fiscal year.

A steady uptick in services exports and remittance flows are going to help narrow the current account gap. In the last few weeks, there has been an increased interest among foreign investors about investing in Indian markets. If you think about it, India assets have become almost 30 percent cheaper in the last 12 months in terms of USD.  As an international investor, especially from United States, one has to be salivating over this “sale”.

The competitive edge in terms of pricing that Indian IT companies lost in recent years has come back with a bang. The cost of off shoring IT work and related services has sharply falling in recent weeks. NRIs have started sending money back home to take advantage of this opportunity.

The challenge for the Indian government is the lack of options to stem the fall of currency and boost economic situation. With elections on the horizon, the government is under tremendous pressure to keep populist policy measures and welfare schemes at the forefront like the food security bill. The finance minister has assured the market that the red line of fiscal deficit of 4.8 percent of GDP will be breached, the impact of this program remains to be seen.

There is no doubt that the current economic fundamentals are stacked heavily against the rupee. However, doomsayers and market pundits should be careful while talking about a further significant decline in rupee.  Our analysis of the current market dynamics indicates that the rupee bears are more like to get gored by the rupee bulls.  We believe that various market factors are likely to help stem the sharp fall in the currency. Additionally, direct and indirect interventions through selling USD and increasing import duty on gold are also going to help the currency, at least in the short-term. Despite so many economic and policy challenges, we remain bullish on India and its economy.   

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Issue Dated: Feb 5, 2017