A strong rupee: why this time it’s different
Since the start of the calendar year the rupee has gained nearly 6 percent against the dollar and 2 percent against emerging market currencies, largely on account of glad tidings on the economy and political fronts. Post demonetisation, it has gained from a strong showing by the BJP in the U.P. election and from parliament clearing hurdles for a GST launch. Crude oil prices continue to remain range-bound, with the OPEC nations curtailing oil production.
The strength shown by the rupee against the dollar and other emerging market currencies has surprised market participants as well as economists. The rupee touched a 21-month high against the dollar to close at 64.05 on Monday, its highest closing since August 10, 2015.
Since the start of the calendar year the rupee has gained nearly 6 percent against the dollar and 2 percent against emerging market currencies, largely on account of glad tidings on the economy and political fronts.
Post demonetisation, it has gained from a strong showing by the BJP in the UP election and from parliament clearing hurdles for a GST launch. Crude oil prices continue to remain range-bound, with the OPEC nations curtailing oil production.
While foreign exchange inflow is one of the big reasons for rupee appreciation, the RBI’s absence in controlling the currency is a bigger surprise. In the current calendar year the country has already seen an inflow of nearly Rs 1 lakh crore or around USD 15.35 billion, resulting in foreign exchange reserves shooting up to USD 375.71 billion. High liquidity in the economy is preventing the RBI from intervening – if the central bank were to sell rupees, it would exacerbate the situation.
The government, too, seems to be in support of a stronger currency; even commerce minister Nirmala Sitharaman, who should be batting for a weaker currency to boost exports, has made a statement downplaying that factor.
So economic and political tailwinds clearly support a strong rupee and better times ahead for India. However, this time around, the rupee’s move is peculiar, unlike any seen in the recent past.
The last time a strong foreign exchange flow and markets were in a strong correlation was during the period 2006-08. An Edelweiss report on rupee titled ‘The Rise & Rise of the Rupee’ points out that in the period 2006-08, the rupee’s movement was below average as compared to other emerging market peers, but this time around rupee is one of the strongest currencies, trailing only Mexico (on account of Trump’s threat receding) and Russia (on account of oil and improving relationship with the US after Trump’s victory).
Not only is the rupee rise among emerging market countries a standout, its movement vis-a-vis other asset classes is also stark. In 2006-08 the rupee’s strength was in line with the strength of hard and soft commodities globally. The Edelweiss report shows that the rupee’s movement was in sync with that of oil, metal and agriculture commodities.
However, presently the rupee’s strength has been despite a flattish or declining performance of all other commodities.
Commodities have fallen off as an asset class since 2008 on account of various reasons. Lower demand and higher supply is a valid reason but more importantly as was seen post 2008, there was lower offtake of commodities at higher prices. Even now a spike in commodity prices results in pullback in demand or increased supplies as is witnessed in the oil market.
While a strong rupee on account of foreign flows reflects the strength of the country in the eyes of foreign investors, it will have an impact on the economy, especially since Indian companies are now going global.
According to Edelweiss a stronger rupee will shave 4 percent off the markets growth and hurt export sensitive sectors. But a more important question to note is whether Indian markets will repeat the performance of 2006-08, when stocks jumped by 40 percent at a time the rupee was stronger by 11 percent.
Given the composition of stocks that make the indices and the fact that more than 50 percent of earnings of Nifty is in foreign exchange, there will be headwinds to the broader market growth. Further, this time around global economic growth is not supporting markets as it did nearly a decade ago.But foreign players seem to be betting on India’s internal growth, which can be seen in the strong performance of mid-cap and small cap stocks as against frontline ones. This time around the rupee’s strength shows the belief of investors in India is more on account of India’s inherent strength rather than a sympathy move in tandem with other parts of the world as witnessed in 2006-08.