Downgrade based on rupee fall: JPMorgan

With rupee at an all-time low of 64.05/ USD and Nifty too opening below 5400, there is no doubt in the minds of most that India maybe heading towards deeper trouble. JPMorgan downgraded India to neutral on the back of rupee weakness. Adrian Mowat of JP Morgan Chase & Co feels India should have been downgraded earlier.

Also Read: JP Morgan downgrades Indian shares to 'neutral'
He continues to remain worried on the country's ballooning current account deficit and is still unclear on the government’s plans to finance CAD. He feels the markets will reverse the downturn once the rupee starts to stabilise. But he adds, policy options to counter the depreciating rupee are rather limited. However, emerging markets with large CAD, such as India, will continue to remain under pressure, he says.
On the other hand, global macro also seems to be stacked against EMs. With US data coming out better than expected, Fed will most certainly begin QE tapering in September, Mowat told CNBC-TV18. Below is the verbatim transcript of Adrian Mowat's interview on CNBC-TV18 Q: You have been relatively optimistic about India. Why this change of heart?
A: It is really all about the currency and the pace of this currency is sliding and the limited options that the Reserve Bank of India (RBI) has in order to mitigate the weakness that we have seen in the rupee. Q: What have you made of the recent policy responses and the fact that it has had such limited response in stemming the currency's fall?
A: I think the central bank clearly is facing quite a number of issues here. We have a global story which is since May we have seen bond yields rise, we have seen redemptions occurring in emerging market (EM) fixed income funds. That is putting pressure on all Current Account Deficit (CAD) countries. We have seen significant weakness in Indonesian rupiah, Brazilian real, Turkish Lira and India is part of that story. There is very little that the central bank can do to counter this.
Unfortunately, the way you have managed down your CAD is you usually put up interest rates, you slowdown growth and you reduce your import bill. Unfortunately for India it is quite dependent on portfolio flows from equity investor and equity investors do not like higher interest rates unlike bond investors. So I think the central bank is quite restricted. There are a few technical things they could do, but I do not know whether philosophically this would be acceptable. If they were to completely liberalise the bond market, allow foreign investors to buy and sell the bond market without having Foreign Institutional Investor (FII) registration or quota then India would become eligible for the global bond indices and you would see quite large passive inflows into India.
As a liberalisation measure it would also send out a positive signal. So I think we will be looking for something as major as that to perhaps turn the tide in the rupee. When you end up with this whole story which is the currency has led the stock market lower. If the currency does turn then the market will turn. As of now we have moved from an overweight to a neutral which partly is to reflect how difficult it is to judge the direction of this currency. If the currency continues to weaken then Indian equities will continue to underperform and an underweight will make more sense. If they cannot stabilise currency then you would get a reasonable short covering rally. Q: So far we have seen only modest selling by FIIs in the Indian markets. Do you fear a selling spree commencing by FIIs now on the back of the impending Fed tapering as well as capital controls by the RBI?
A: The way I would describe the sequencing here is as we move into September which is when we think tapering will start we will certainly get bond market volatility. Our view on bonds will weaken, yields will rise and so it is likely that the pace of redemptions in EM fixed income funds remain significant and the pressure will continue to be on EM currencies, particularly those countries with larger CADs such as India. As international investors try and protect the dollar value of their portfolios they will want to reduce their positions in India. When we look at the positions in active EM funds, India is a consensus overweight and so it is technically vulnerable that you do get FIIs selling.