Gold, oil fall has improved current account state: JPMorgan

The continuing depreciation of the rupee is because of two factors - current account and capital account, says Brijen Puri, head FX trading, JPMorgan. The current account is made up of high oil prices and high gold imports and on both counts which has been some progress over the past month, improving the current account situation.

Commodities which fell sharply last week on global growth fears were firmer on Monday, with Brent crude clambering back above the USD 91 per barrel. Oil is on course for its biggest quarterly fall since the 2008 financial crisis, as a declining US recovery and slowdown in China clouds energy demand while OPEC keeps supplies ample.
Gold, which lost nearly 3.5% last week amid fears that developed markets could be sliding towards deflation, was steady around USD 1,573 an ounce.
“It’s the capital account which has been a little shaky with the downgrade and the European debt crisis, therefore putting questions on our funding situation as well as exacerbated by FCCB repayments,” says Puri.
He finds that the fall in the rupee is over-extended and expects some support soon. But according to him, the hike in the FII limit will not have a significant impact on rupee. Below is an edited transcript of his interview. Watch the accompanying video for more. Q: The big rally in expectation of recommendations and announcements from the government and what is the chatter in the money market in terms of what may come through on specific recommendations?
A: I think, yes, the market is really looking for some action. It did seem a little overextended and probably is currently also. It’s important to recognise that from a fundamentals perspective, the rupee underperformance had two parts. One was the current account part and the second was the capital account part. The current account part being high oil prices and high gold imports. On both of those over the past month or thereabouts we have seen some improvement.
So with oil prices coming off just back-of-envelope calculations would tell you that our oil bill should come down by anywhere between USD 1-2 billion a month which is anywhere between USD 12-20 billion a year which is fairly significant, anecdotal evidence also talking about gold imports coming off. The current account picture has been improving a little bit.
It’s the capital account which has been a little shaky with the downgrade and the European debt crisis therefore putting questions on our funding situation as well as exacerbated by FCCB repayments. So I think the picture has improved a little bit on the fundamental perspective, however the noises had been negative.
The market today is rallying a bit on expectation of announcements. The expectations range from some more administrative measures like some more freedom regarding pricing of FCNR-B deposits, increase in debt-FII limits, a bond issuance either of the RIB, IMD variety or sovereign bond issuance. So really the markets in a wait and watch mode as to what really comes out during the day to go forward from where we are. Q: To assess the impact on the rupee-dollar rates. The easiest one to evaluate is probably the extension of the sealing on corporate bonds or government bond limits for FIIs. What is the likelihood of that? Say an additional USD 5-10 billion were allowed, how much of a pullback can it do for the rupee from what has happened already this morning?
A: Frankly, I don’t think tweaking around too much with the FII limits will have as much of a material impact on the rupee. If we see the FII limits also there are two parts to the chatter. One is an increase in limits and the second is tweaking around saying we will remove some of the restrictions that we have on either the corporate bonds in infrastructure or the government securities limits.
However, I don’t think that will have much of an impact because really a lot of these flows have been coming in on a fully hedged basis. A percentage of the flows the un-hedged part is fairly small. What it does is while it improves the dollar supply in the cash market, from an FX perspective it’s not as material an impact and if that is really the only measure that we see then the market would be fairly disappointed. Q: What about the other one which is the Millennium India Bond, the Resurgent India Bond kind of a program? If that were to come about how significant an impact would you see on the rate?
A: Probability wise, I would think given what we have been hearing and given the global environment, it’s probably lower down on the probability chain. However, from an impact perspective, that is something which will have the maximum impact because if we do have an issuance of that sort, I would assume the amounts would be somewhere between USD 10-15 billion or maybe even in a USD 20 billion range.
That kind of flow is something which the market would definitely take note of and that could materially move the dollar-rupee lower, maybe 2-3% or even more from where we are. What is important is to see what kind of measures that is followed up with because while this is what we will get from the RBI or an RBI-government perspective, the market is very keenly watching on and has high hopes from the new economic team being formed in Delhi and what kind of measures would come out from there. That is something which is very important as a follow-up to ensure that any rupee gains that we see post announcement of the measures have any probability of being sustained. Q: What about an extension of existing policies - to clamp down further on gold imports to look at some kind of interest rate hike for NRI, NRE deposits? How significant a move or a couple of moves do you think that will be?
A: Those would all be moves on the margin front and given the way the sentiment has been playing out overseas, the impact would be solitary and probably 1-2%, but unless we see that followed up by other action from New Delhi, the market would probably look at that as an opportunity to build up longs again. Q: In terms of hiking the FII limit to a specific amount - over USD 30 billion and the second considering a cut in withholding tax, how material would that be you think from the rupee’s point of view?
A: A cut in withholding tax would be important, because really that is something which the real money investors have been unhappy with and if we do see a removal of withholding tax on both government securities and/or corporate bonds, that could have a little bit of a positive impact. Just a plain hiking of limits within the current paradigm would have very limited impact.