-----
Rajeev Malik, ED, JPMorgan Chase Bank, Singapore
The recent depreciation of the rupee against the dollar has been sizeable but orderly, packed within a short time, and caught almost all off-guard. Interestingly, the Reserve Bank of India (RBI) has not intervened in the foreign exchange market. There are four key factors behind the recent depreciation: (1) recovery of the US dollar; (2) higher global crude oil prices, which widen the current account deficit and also increase dollar buying by oil companies; (3) slowdown in capital inflows, which decreases the supply of dollars; and (4) unwinding of positions that were betting on rupee appreciation to check inflation.
Analysing the evolving balance of payments dynamics is crucial for figuring out where the rupee is headed. Surging crude oil import bill, continued strength in domestic demand, and expectations of moderating export growth suggest that the current account deficit will worsen this fiscal year, probably to slightly more than 2% of GDP. A $10/bbl increase in crude oil prices increases the merchandise trade deficit by around $6.5-7.0 billion. Higher global crude oil prices also boost remittances, but the net effect of higher oil prices on the current account deficit is still a large negative.
Capital inflows are unlikely to maintain their strength in recent years, though funding the wider current account deficit should not be a problem. The overall balance of payments surplus will probably narrow to a mere $24 billion (1.8% of GDP) in 2008-09 after the multiyear high of around $90 billion (7.6% of GDP) estimated for last year.
It should be clear to all that the RBI and the government are not in favour of using the currency to check inflation. But why has the central bank not intervened to check the rupee’s weakness? Less favourable balance of payments and the RBI’s asymmetric approach to rupee’s appreciation and depreciation explain its absence in the currency market. Still, the RBI is unlikely to allow the rupee to depreciate beyond 44. Interestingly, that is close to the level where the central bank was reportedly pummeled last year into letting the rupee go.
Firms that had raised external commercial borrowings (ECBs) and happily kept the proceeds unhedged assuming super-optimistic scenarios for the rupee should be losing some sleep. Admittedly, a weaker rupee will increase the subsidy bill for the government but the impact will be marginal on a situation that is already on an unsustainable path for reasons that have nothing to do with the RBI. In particular, the government should not rush into easing the restrictions on ECBs. It is somewhat amusing that that many of the analysts who argued for no RBI intervention when there was pressure on the rupee to appreciate are now making the case for intervention to avoid depreciation!
The rupee could weaken to 43.5-44 against the US dollar, unless either global crude oil prices ease or there is a sharp improvement in global risk appetite that increases capital inflows into India. Further delays by exporters in converting their export earnings will increase the mismatch between dollar supply and demand, thus strengthening the case for further rupee weakness. However, the weakness will not last long, and we will probably end the year on a stronger note relative to the weakest point.
Importantly, the rupee’s medium-term appreciation story remains intact. The currency — like the broader economy — is mainly reacting to some near-term headwinds that have brought about a welcome correction in hype over the India story. But there is an important lesson for all, especially the uninitiated: even currencies that are expected to appreciate sometimes go off-course. Get used to flexible exchange rates, and manage risk in a better manner.
-------
Ajit Ranade,Group Chief Economist Aditya Birla Group
Back in 2002 when the first draft of Goldman Sachs BRIC report was being written, the rupee was at 49 to the dollar. The BRIC report predicted (and still does) that India would be the third-largest economy in the world by 2050. That translates into a growth prediction of almost 9% per year for fifty years. What was implicit but perhaps not headlined, was that this growth was in dollar terms. Which means that implicitly the BRIC report predicted a rupee appreciation of more than 2% for fifty years.
As per that prediction, in the first six years the rupee would be stronger by about 13%, which is exactly where it is today. Experts will quibble whether this is Goldmans golden touch at prediction, or just luck. For after all, the rupee didn’t get from 49 to 42 in a steady linear fashion. Its appreciation overshot to almost 38 before getting to where it is today.
If you ask about fundamentals look at the broad macro context. Firstly, oil rules at 125 (the veritable Goldman crowd is calling for $150 to $200 per barrel in the near future). Secondly, there will be national elections in the next twelve months. Both these factors are very negative for the fiscal situation. Thirdly, inflation is raging at close to 8%. Fourthly, the current account will be worse than last year, with trade deficit already threatening to be 10% of GDP (thanks again to oil prices).
All these factors point to a rupee which will slide. On the flip side are four factors which will mitigate rupee weakness. These are global dollar, growth optimism, capital inflows and the Reserve Bank. The dollar’s global weakness is manifest whichever continent you look at. Euro, yen, the Canadian and Australian dollar are all very strong, albeit reluctantly. Even the Brazilian real, or Egyptian pound continues to strengthen. Only the Korean won or Indian rupee may be exceptions. The second factor is continuing optimism about India’s GDP growth from domestic and international investors. Thirdly, as the global credit crunch gradually recedes, capital inflows into India in the form of FII and FDI, including private equity will improve.
Lastly, if the RBI re-opens the ECB tap, there are many Indian corporates who will eagerly seek cheap overseas funds. That is also a part of capital inflows, although the tight global credit markets means ECB inflow won’t be as vigorous as in 2006. If the RBI removes the restriction on automatic approval for borrowings below $20 million, that too will increase ECB inflow.
The rupee gained by almost 20% in the last two years but lost 8% in the past six months (thus enabling Goldman to be on the dot). Hence the medium-to-longer term outlook for the rupee is further strengthening. But the current weakness will remain until (a) inflation moderates; (b) ECB restrictions remain and (c) the international growth optimists don’t rush back into India.
It is misleading to use words like fundamentals for a currency. Unlike real assets which produce real returns, and hence can conceivably compute the present discounted value of future stream of returns, there is no such fundamental objective value for currency. There is a real effective exchange rate based on purchasing parity. But reversion to that level happens only over a medium term. In the interim, herd behaviour can lead to wild swings. The RBI’s job is a struggle between non-intervention, trying to keep volatility low and creating awareness about risk and currency hedging.
The rupee may regain upward momentum later this year. What’s much more certain is continuing structural strength of India’s growth, and the gathering of the dark fiscal clouds.
--------
Udayan Bose, Chairman, Thomas Cook
The outlook for the Indian rupee has gone through a drastic change in the last few weeks. The rupee which was in the news in 2007, for being one of the best performing Asian units, has now suffered one of its steepest slides versus the greenback.
In 2007, it was a one way slide, a major correction in the first quarter and rupee never looked down, reaching a high of nearly 38.5 against the US dollar. Importers were rejoicing, travellers were in joy for being able to buy dollars at relatively cheap value. Equally the inbound tourist received less for the dollar and wondered whether the money changers were doing him a rope trick.
While the pundits like The Economist were predicting an even stronger rupee in 2008, the trend reversed since beginning of this year. From highs of 38.5 against dollar, the rupee plummeted and touched a low of 42.67 per dollar and is now slowly moving towards the 43-mark. The (partially convertible) rupee has fallen more than 7% to a 13-month low this year reversing a 12% gain in 2007. Most of the decline coming this month.
The general view is that this is as a result of the $122 per barrel oil price of crude in the international markets. While this is one of the important reasons, there are others, such as inflation, which has been the highest in recent years, large outflows for oil purchases and proceeds of sale in the stock markets by international investors, all of which is leading to a widening trade deficit.
There is a large demand for dollars in the market and because of the international slowdown in capital markets, the inflow of FII money is slow, hence creating a demand-supply mismatch. Hence I cannot see a quick reversal for the rupee to become strong in the near term.
The good news is that fundamentally the economy is in good shape and the debate extends to only whether the growth this year will be 7.5% or 8% or marginally higher than 8%. But the matters to worry about are quite a few. There is a humongous deficit in the oil pool deficit account, which not only our petroleum minister, but even the prime minister has conveniently forgotten about.
Then we have to provide for the Rs 60,000 crore largesse to farmers, then the Rs 25,000 cr largesse towards the government employees happiness fund. When the next government tries to raise money for these excesses, will we see a set back to the fiscal deficit regime? Inflation continues to be a worry, mostly because it is a supply side inflation and only a global supply side correction will ease up the situation in India. Current interest rate and bank fund squeeze will also perhaps result in a 7% or sub 7% growth rate next year? Those are the worries and serious ones at that.
The direct consequence of rupee weakening sharply of late is that sectors like oil, cement, steel, pharmaceuticals, telecommunications, will be affected. Either because imports will be expensive or because the foreign currency borrowing will result in larger rupee payouts. However, exports, which were hit by a dearer rupee, will become easier.
I know that when the rupee had strengthened to 38 levels, garment exporters were having serious difficulties. Information technology companies’ software contracts were becoming unprofitable. Some of the software companies’ results were already showing the initial effects of this strain. Foreign exchange business also had dried up. All these companies will do well now and the smile will be back on their faces.
But the portents overall are not good and fiscal correction is long overdue. Or else we will face a tough 2009.
