Wednesday, 21 August 2013

Indian Rupee in Free Fall

Rupee in Free Fall
The Indian Rupee has been on a slippery slope ever since the FED announced its intent to taper its Quantitative Easing (“QE”) program. 
Most EM currencies with the exception of Thai Baht and the Philippines Peso have also suffered large declines. 

The Rupee plunged to 64.55 to the dollar on 21 August 2013 before closing at 64.11.  Over the last 3 months, the Indian Rupee has declined by a whopping 17%.  The Indian stock market has plunged 5.7% in two days eroding over USD100bn in value.

Ever since the announcement of QE tapering by the FED, the US Treasuries 10 year yield has spiked by over 85bps (from ~2% p.a. to 2.84% p.a. YTM). 
Such a whiplash move eroded the market confidence with equity and bond markets recording massive correction triggered by the significant unwinding of carry trades. 
Foreign investors have unloaded over US$10 billion of Indian debt since May 22, when the U.S. Federal Reserve first signalled its intention to begin scaling back its quantitative easing leading to bond yields to exceed 9% p.a.

In addition to the above growth is at a decade low, trade and current account deficit are at record highs, fiscal deficit is high and retail price inflation is in double digits.  And to top it the price of onions and the Fx rate are in a race to get ahead of each other!  Meanwhile, the government is engaged in pushing its fiscally irresponsible populist policies with an eye on the forthcoming elections in 2014.

Is it Deja vu ?

So, there is a sense of déjà vu amongst commentators on the recent slide in the India Rupee with many likening this to the 1991 Balance of Payments Crisis.  While there are some striking parallels of this to the earlier crisis, the underlying factors are quite different.  In 1991, India was staring at a sovereign default as the Foreign exchange reserves had dwindled to less than two weeks worth of imports. Then, the government had resorted to draconian measures such as direct import curbs, ultimately mortgaging gold reserves with the IMF to raise emergency funds.

Now, there is no such risk. Despite the recent fall in reserves, India's foreign currency assets are at USD 280bn is enough to cover seven months imports.   On the questions around the ability to meet the Current Account Deficit whether its USD 60bn or USD 80bn, the foreign x reserves at around USD 300bn can fund it.  A bigger issue could be the refinancing requirement of USD 170bn odd coming up in 2014.

Also, software exports and other invisible inflows in 2012-13 were equivalent to more than half of India's trade deficit that financial year. On the eve of the 1991 economic crisis, inflows of invisibles were negligible; these were negative in 1989-90. This essentially rules out the possibility of a 1991-like economic crisis, when the gross domestic product (GDP) growth collapsed from a healthy 5.3 per cent in 1990-91 to 1.4 per cent the next.  

In summary, 1991 was a Balance of Payments Crisis while in 2013 it’s a confidence crisis arising from policy paralysis, fractious government, corruption scandals and misplaced policy priorities.  In essence, the Indian Rupee has become the barometer of the current UPA government’s performance in many respects.

The high economic growth over the past decade led to an increased affluence as well as certain amount of hubris.  While the fundamentals are much stronger now than they were in 1991, the stakes are much higher now and hence the fear of losing the new found affluence has set in.

In order to arrest the slide of the Rupee the government has been announcing a series of measures to very little effect.

So do the measures announced add up ?

India’s Finance Minister announced that he expects USD 11bn of additional capital inflows during the remainder of FY14 (ends March 2014) once the following new measures are implemented:
1.       easier overseas borrowing norms, especially for oil companies (USD 6bn);
2.       liberalisation of the non-resident India (NRI) deposit scheme (USD 1bn);
3.       issuance of quasi-sovereign bonds (USD 4bn); and
4.       import duty hikes.

While fresh US dollars (USD) will be raised, some areas of concern are outlined below :

Liberalisation of the NRI deposit scheme to add another USD 1bn

While formal notification is awaited, in his press conference the FM announced that the interest rate on foreign currency-denominated NRI deposits of more than three years maturity will be deregulated.  This should allow banks to set higher interest rates for its foreign currency deposits.

As is to be expected, it's a wild range as no one can yet get a steer on government's strategy.  But impact of some of the actions on INR are assessed below :

The RBI announced more measures to contain the net outflows from India

While accurately quantifying the impact is little difficult (estimate it as at least USD 2-3bn) but these measures together with several other announced measures till date should ease the pain on funding a wider Current Account Deficit.

First, it has reduced overseas direct investment limit for an Indian company in all its joint ventures/ wholly owned subsidiaries to 100% of their net worth (as per the last audited balance sheet) versus the earlier limit of 400%. Few publics sector companies like those in oil sector are exempted from this restriction. If a company wants to invest more than 100% of its net worth it will now require RBI’s approval.  However, breakdown on specific type of outflows are not available. However, in FY13 India witnessed USD12.6bn of FDI outflows and even if this has a 10-15% impact this should provide some relief.

Second, it reduced the limit for outward remittances by resident individuals by 60% from USD 200k to USD 75k only. Also, use of such remittances for acquisition of immovable property is not allowed any more. In FY13, Indian remitted INR1.2bn under this scheme out of which INR 80mn was for acquisition of immovable properties (see snapshot below). During the April-May 2013, India remitted INR300mn.The outflows should reduce unless more individuals start remitting in other names (eg, close relatives). Innovative Indians will find a way by using their relatives and friends!

FX impact: The announcement of the USD 11bn INR rescue plan on 12 August, provide the authorities another window of opportunity to come up with stronger steps to address Current Account deficit financing concerns. Before this the government had limited Gold imports and then levied 10% import duty.

Rising yields on government debt will also force banks to write down the value of their bond portfolios. To ease the pressure on banks, the RBI carried out Open Market Operations adding USD 1.2bn to the market liquidity by purchasing long dated bonds today (21 August 2013). The banks valuations were impacted by the series of measures taken earlier and today’s actions resulted in a strong rally in bank stocks.  The bond yields had risen to 9.47% (last seen during Lehman crisis in 2008) and with the current action it has fallen to 8.93%.

The latest moves partially reversed previous monetary tightening measures and led to accusations from analysts of Indian policy “flip-flops” just as the governorship of the RBI is passing from Duvvuri Subbarao to Raghuram Rajan, the former International Monetary Fund chief economist who takes over on September 5.

Market is not convinced

While these measures should help ease the upside pressure on USD-INR, market continues to await further announcements like import duty hikes, external bonds etc. before evaluating the impact of all measures.  USD-INR is expected to enter into a short phase of choppy range trading as India’s BoP dynamics are reassessed. There is a risk that international investors view these steps as retrograde leading to panic buying of USD-INR.

Powerless so far to rein in the wayward rupee, the government even pleaded with gold-obsessed Indians to stop buying the metal, because it drains foreign exchange reserves.

Far from reassuring investors, the mish-mash of measures has created the impression that the Indian authorities are floundering around for stopgap solutions rather than devising any long-term strategies for economic recovery. 

Amidst all this cacophony, the market is taking an extreme view as they see the government’s measures are with no clear policy direction and is ham handed.

What are some of the pundits saying?

The issue has caught everyone’s imagination and several self appointed ‘experts’ are advising the government!  Here’s what some experts are saying :

·         The PM and the FM to visit the holy shrine in Tirupati, not for praying as the headlines suggested, but to negotiate with the Trustee to deposit their 500 tonnes of gold with the State Bank of India; 

Some superstitious Indians have blamed the slump on the new symbol for the rupee, unveiled last year. Experts on “Vastu Shastra”, Indian version of “feng shui” say that the symbol debuted on an inauspicious day and that the horizontal line across the symbol appears to “slit the throat” of the currency!

What should the government be doing?

The immediate task is to improve its communication to the Market of its package of measures together with a strategic policy direction.  Markets hate uncertainty and to the extent this can be taken off the table, it improves the overall sentiment.

1.       The Government needs to address the cause rather than attack the symptom even as they take some tactical measures.  To start with create a predictable investment climate with no policy flip-flops (e.g. Vodafone tax case). Many potential investors have been frightened by an unexpected US$ 2.5bn tax demand levied on Vodafone after it acquired the Indian mobile operator Hutch.  Accept the Supreme Court verdict and create an environment of predictability of economic and fiscal policies.

2.      Reverse confidence destroying moves like limiting remittances by individuals. This can only result in panic reaction stemming from the fear of total capital controls leading to flight of NRI deposits.

3.     Address structural issues by investing in infrastructure projects and help drive business growth. The prospect of the return of strong growth will in itself result in strong inflows.

4.     Raise foreign currency funds through either corporate or sovereign bond issuance or by incentivising the NRI deposits.

5.  Consider appropriate monetary action to anchor long term interest rates to support credit and economic growth.

6.       Put fiscal discipline ahead of populist measures.


The long and short of it is, no one has a clue on where this train is headed but everybody is worried about a looming crash. Forever, the optimist, I reckon that the Finance Ministry and RBI would come up with the right medicine eventually to check and reverse the runaway slide. Until then Rupee will continue to test your nerve !

Near term outlook is that the Rupee might test 65 and worst case outlook is that it may even sink to 70 to dollar over the medium term.

Such an outcome will further burden the already strained corporate balance sheets, squeeze credit flow besides fuelling inflation and crippling growth.

The government’s pursuit of populist policies but fiscally irresponsible has wrecked the script of the India story and crippled the potential of what was once as the ‘fastest-growing free market democracy” as was touted in Davos not so long ago!

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