Rupee fall to relieve corporate sector temporarily

India Ratings believes industrial sectors such as cement, chemicals, paper, capital goods, steel and trading, which are the worst impacted by rupee depreciation, may have enjoyed a temporary reprieve from September to mid-October 2012 when the Indian rupee (INR) gained strength. However, the rupee strength is waning to the extent that in the second half of October 2012, it was one of the most depreciated currencies against the USD. Additionally, global event risks in the next 12 to 15 months may potentially push the rupee to depreciate well past its historically observed levels.

India Ratings, in its report ‘Impact of Rupee Depreciation on Investment Grade Corporates’ dated 3 July 2012 analysed, the impact of the rupee falling to INR60/USD1 on Indian corporates. For the sectors mentioned above, any INR5 depreciation against the USD typically reduces operating margins by 2% to 4%. However, to the extent the USD exposure is effectively hedged operating margin would be impacted by less than 1.0% only.

Corporates which used the period of rupee strength to hedge their exposures, either operationally or through the use of financial derivatives may be better placed to protect their operating margins in an environment where the currency may experience enhanced volatility. However, corporates (particularly the above-mentioned sectors) which have been lulled into a false sense of comfort may be more negatively impacted, since the continued weakness in domestic demand would further limit their ability to pass on high costs attributable to rupee depreciation.

The report was published when the INR/USD rate was at 55.34. The rupee movement was compared with the currencies of 18 countries representing prominent emerging markets. The analysis suggested while the movement in the local currency against the USD may be driven by fundamentals, the huge depreciation observed in currencies of countries such as Brazil, South Africa, Mexico, Turkey is determined by global risk aversion.

The rupee strengthening can largely be attributed to three global announcements since July 2012 which led to a surge in liquidity and reduced global risk aversion resulting in capital flows to emerging markets. On 6 September 2012, European Central Bank announced to buy new and unlimited bonds for easing eurozone debt crisis (Draghi’s Announcement) and The Federal Reserve on 13 September 2012 announced open-ended purchases of USD40bn mortgage debt a month (QE3). The latter nearly coincided with the government of India’s (GoI) announcement of a diesel price hike (and capping of subsidised LPG cylinders) and foreign direct investment (FDI) in several sectors including multi brand retail and aviation.

India Ratings observed that within the group of 18 emerging countries, the currencies of 16 countries appreciated against the USD during 6 September and 13 September 2012. The INR/USD appreciation was 1.09%, higher than the median appreciation of 0.9% within the group. After the QE3 announcement, all 18 currencies appreciated with a median monthly return of 0.49%. The policy initiatives by GoI provided an extra fillip to the INR which appreciated the most (5%) within the group during 13 September to 13 October 2012. However, the trend reversed by end-October 2012 where the rupee depreciated the most (negative 2.7%), highlighting that global events and risk aversion would remain key determinants of currency movements. The median depreciation for the currencies during the period was only 0.04%.

However, the depreciation of INR against USD, may also be, to an extent, attributed to re-emergence of global risk aversion particularly towards major emerging markets. An analysis of credit default swaps (CDS) spreads of emerging nations suggests that after 15 October 2012 the CDS spreads of major emerging nations such as South Africa, Brazil, Russia increased by at least 10%, reflecting enhanced perceived risk. A significant and continued reduction of CDS spread was observed for peripheral eurozone nations, who are likely to be the direct beneficiary of the Draghi announcement.

During the next 12-15 months, several potential events may increase global risk aversion and adversely impact capital flows to emerging markets. These events are the result of the approaching 'fiscal cliff' in US, further deterioration in eurozone debt crisis and enhanced politico-economic uncertainty in China.

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