The Indian Rupee is witnessing its worst time ever, with more than 14% of depreciation since January 2012. The rupee had made an all time low of 56.51 levels against the dollar in May 2012.
The rupee started depreciating from August 2011 when it was around 46 levels. The poor macroeconomic fundamentals, rising fiscal deficit and current account deficit, which is highest among the Asian countries are the major factors responsible for the havoc created in the local currency market. The government estimated the fiscal deficit to be around 5.1% in current financial year 2012-13, as compared to 5.9% in 2011-12. The Current account deficit was recorded at 4% of the GDP in 2011-12, worst since 1991.
Our country is suffering from very poor economic fundamentals and trade gap which is currently at $185 billion, the highest among the Asian countries. This is creating an excess of dollar demand in the market for import payments & outflows and hence making India a worst performer on currency terms vis-a-vis dollar. The Government authorities are always seen blaming the International issues such as economic trouble in Europe and stronger dollar overseas for weakening local currency. But the weakness of rupee started much before and there are long term structural issues like current account deficit and burgeoning credibility issues plaguing the economy. The country is trapped between political and economic uncertainties with a combination of fiscal populism and policy paralysis with some big corruption scandals.
The government promised several measures which were to be undertaken like FDI clearances in retail. This would have given the economy a larger boost of investment and FDI to fund the grappling infrastructure and the uncontrollable current account deficit. It is also to be noted that lot of FDI from the country is moving out due to poor investment opportunities and bureaucratic structure in India.
If we know that we cannot reduce trade gap through excessive exports then we should have focused on import substitution like that of Hong Kong, Taiwan, South Korea who has practiced the same over the years. In turn we have been increasingly dependent on overseas investments in form of FII to bail us out every year.
The situation is quite grave at this time with slowing economic growth and weakening currency. The latest GDP figures have slipped down to 5.3% for the first three month of the year 2012, worst in last nine years. The Indian Economy is expected to decline further on account of the weak local fundamentals and international slowdown in Europe and China.
To support the rupee, the government introduced measures such as enhancing the limit for foreign institutional investment in debt and raising the import duty on gold by 300%. RBI tightened the norms for rupee forward contracts for exporters, importers and banks to avoid speculation. It had also established a $15-billion bilateral swap line with Bank of Japan, raised interest rates on non-resident deposits and announced relaxations in external commercial borrowing.
It had a main focus to intervene at regular intervals by reducing the dollar demand side in the market but all the measures were taken negatively by the market pushing dollar to new highs. The RBI also sold the dollar to support the rupee. The RBI intervention was recorded to USD 20.13 billion for the duration September 2011 – February 2012. In fact these interventions do not bring about the fair value of the currency and the USD/INR market will react abnormally when these sanctions or interventions on dollar is removed.
The Foreign institutional investors also pulled out $174 million from Indian stocks since April, reversing their optimism seen during the first three months of the year when they bought Indian stocks worth $8.8 billion. They turned net sellers of Indian stocks in April, the first month of withdrawals in 2012, due to changes in tax rules and Indian Government failed promises.
In May 2012, we saw net outflows of Rs 4.33 billion i.e. USD 77.15 million. Investors from overseas bought a net of USD 619.3 million in debt and equity market in the month of May, much less than USD 7.2 billions of inflows in the month of February 2012.
The demand for the safe haven US DOLLAR, due to ongoing concern over European region is also further adding to its strength and rupee weakness. We can see Dollar index strengthening further and breaching towards 85 levels as seen 90 in March 2009 and 92 in 2005 and an all time high 120 in 2001.
The most important point to be noted is that US dollar is the reserve currency and there is no alternate safe haven as liquid as the US dollar. Investors across the globe are already investing in this currency for 10 years at a yield of 1.45% all time low since 1912.
Recently the market had talks of having another round of QE3 but we feel that the Federal Reserve is still in the middle of doing its Operation Twist program. It is difficult to really see the Federal Reserve implementing another quantitative easing program at this time. Till any official announcement is made on QE3, we maintain strength in US Dollar overall in 2012. We expect the Dollar Index to hit 85 soon and rupee weakness overall with global uncertainty increasing.
The Euro Zone is little quite before the Greece election which is scheduled on 17th June 2012. The election could well produce a government determined to renege on or radically renegotiate the reforms and austerity measures. If that happens, the rest Europe will have to decide whether to be party to those negotiations or to walk away. If we do not see any radical step being taken on Greece then others may follow suit like Spain, Portugal etc which are also grappling with the crisis
Coming back to the Indian Rupee, there is not much change in the local fundamental which would support the rupee. The upcoming RBI monetary policy on 18th June 2012 will be very challenging for the Central bank officials as the growth has slipped to nine year low levels with food inflation lingering above 10%. I feel before making any decision regarding the rate cut, RBI will be having a very close look on the IIP and Inflation figures which are scheduled before the policy review.
Checking out the debt status, nearly 43% of the total external debt of USD 316.9 billion are coming up for maturity in the current year which consist of NRI deposits of USD 43.4 billion, 32% of the total short term debt of residual maturity of less than one year, FII investment in sovereign debt of USD 5 billion and ECB of USD 20 billion.
The current conditions where the Indian Rupee has depreciated against the USD in the last few months and the rise in credit spreads in Indian USD bond issuers has placed a stress on USD funding of domestic borrowers. Hence the maturity of short term debt of USD 137 billion in the coming months would make further pressure on rupee.
Talking about the impact on layman, the depreciation of the rupee has resulted into imported inflation. Being a net importer nation, the rupee weakness has affected general food prices and consumption patterns in the country. The wages do not increase in the same pace making it difficult for the common man.
Also the cost of studying abroad has increased by 20- 25% making it difficult for the students aspiring to study abroad. The proportions of bank loans have not increased at the same fashion though. Even the traveling cost has increased by 20% making it difficult for the mid-sized business man who travels abroad for business purpose.
The surging gold price in the local market, due to rupee weakness is making it increasingly difficult for buying gold gifts for marriages in a gold driven society. In short we can say rupee weakness has increased the burden on the layman’s pocket. The point to be noted is that increasing prices will make the individual spend more and save less. Reduced saving will impact the investment cycle which is very important for the growth of the economy.
We all know India is one of the fastest growing economy with youngest population in the globe and having one of the highest interest rate differentials. If we are unable to attract inflows when so much of money is printed everywhere across US, Europe, Asia then it is a cause of serious concern.