Rupee weakness to persist until major steps by policymakers

By Dinesh Thakkar, CMD - Angel Broking

The Indian economy is battling with a host of factors, from uncertainty on the political front to slowdown in economic growth, followed by the poor performance of the Rupee against its Asian peers. A combination of external and internal factors have made Rupee the worst performing currency this year and while the central bank is targeting to reduce volatility in the currency, the macroeconomic concerns are having a bigger impact on the currency. Over the years, the value of the Indian Rupee has weakened sharply from a level of 8 per dollar in mid-1974 to above 55 currently. Talking about the period post 2000, the Rupee witnessed stability between 2000-2007 and was in the range of 44 to 48 per dollar. But post-2007, a remarkable trend was seen as the currency appreciated significantly and touched the 39-mark, mainly backed by an increase in foreign investment inflows. Although appreciation in the Rupee was positive, its impact on companies involved in exports was very negative. But the current movement in the currency is a matter of concern with India dependent on imports for around 70 percent of its crude oil requirement. With the oil import bill rising year-on-year, the current scenario of a weaker Rupee has led to a havoc. At the start of the year, the currency had largely stabilized due to optimism that European policymakers would take active measures and steps to resolve the debt crisis. This led to capital inflows in India for the months of January12, February’12 and March’12 which stood at Rs10,357cr, Rs25,212cr and Rs8381cr respectively. But in April’12, a reversal in investment flows was seen with outflows to the tune of Rs1109cr, which eventually led to pressure on the Rupee. The measures announced by the European policymakers surely lifted market sentiments in the first-quarter of this calendar year, but thereafter pessimism sunk in again as all measures had a long-term perspective. During February’12, the Euro group along with the IMF and the Institute of International Finance agreed on the final conditions of the second bailout package worth €130bn. The EU members also agreed to lower interest rates of the Greek loan facility to just 150 basis points. Despite these measures, credit ratings downgrade of various European economies triggered a wave a risk aversion in the global financial markets and India too was affected. Apart from falling investment inflows, it is the widening trade and fiscal deficit that put a downward pressure on the Rupee. Weakness in the Rupee has become a negative factor for the Indian economy as imports of commodities becomes more expensive than before. In a recent bid to tackle Rupee depreciation, the Reserve Bank of India (RBI) asked exporters to convert half of their foreign exchange reserves into Rupee in order to make dollars available in the markets. A high current account deficit (CAD) has added to the woes of the Rupee as imports of goods and services exceeded exports. At the end of December’11, the CAD had touched 4 percent of GDP, but for the current fiscal the CAD is expected to be lower on the back of a fall in oil and other commodity prices.  As far as the fiscal deficit is concerned, for the FY2011-12 it stood at 5.7 percent and for FY2012-13, it is expected to be around 5.1 percent as forecasted in the budget. The macroeconomic scenario has deteriorated considerably and the Indian economy too is under stress. Capital outflows in May’12 stood at more than Rs600cr, and in the same period the Rupee has depreciated by 5 percent. Dependence of Rupee’s movement on the investment inflows has created a catch 22 situation. India would now need to move on from temporary investments to stable avenues like FDI. The chart below shows that the Rupee has appreciated when inflows in the country have risen and depreciated in times of outflows. In the current calendar year, the average value of the Rupee on a yearly basis has weakened sharply to 51.32 (year-to-date). During the same period the average value of the US Dollar Index (DX) has increased sharply to 80.07 on a year-to-date basis. At the end of last year, the DX stood at 80.50 and has jumped significantly to around 82.50 currently. Strength in the DX has also contributed to weakening of the Rupee, but grim FIIs are the main factor contributing to weakness.                     On the import front, a weaker Rupee will increase the cost of imported commodities, with the most important being crude oil. The Rupee has weakened considerably and led to a rise in value of oil imports. In the past two years however, oil prices had also increased and this coupled with a weaker Rupee added to a higher outgo in terms of payment for oil imports. In the current context, oil prices in the international markets have corrected considerably, but the value of the oil imports will not deteriorate due to Rupee weakness and the Indian economy would struggle with the burden.                     In the current scenario, structural reforms by the Indian government are very necessary so as to control further weakening of the Rupee. From the short-term perspective, weakness in the Rupee is expected to persist as the currency has shown a subdued and short-lived reaction to the RBI’s interventions by way of OMO or by way of asking exporters to convert half of their foreign exchange reserves into rupees. Hence, taking into consideration the external and internal economic factors, we feel that depreciation in the Rupee would continue in the next two-three months and we expect the currency to test levels around 57 to 57.50. For a brief period in between, we could witness appreciation in the currency to levels around 54 to 53.60 as global leaders get together to chalk a saving plan for the Euro region. This is expected to bring in short-term relief for the markets, but from a longer term perspective, these announcements may not prove beneficial until and unless they are implemented immediately. Disclaimer: The views and investment tips expressed by investment experts/broking houses/rating agencies on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.