BackRupee’s record slide brings pain and gain for India
A look at the impact of a sharp depreciation on the economy and various sectors
Premium(Mint)
Mumbai: The Indian rupee traded at a lifetime low of 58.67 to the dollar on Tuesday on continued dollar strength against emerging markets as well as major global currencies. The domestic currency opened at 58.30 and rapidly weakened. It closed at 58.14 per dollar on Monday.
The local currency is not alone in depreciating against the US greenback, but it has lost the most value since the beginning of May among major emerging market currencies except for the South African rand. That is attributable to India’s own problems such as a high current account deficit.
Finance ministry officials played down the rupee’s movement, saying it was in sync with other global currencies. There is nothing to panic, they said assuringly, even as currency traders and experts remained divided on the rupee’s future direction.
“It looks like this weakness will continue for the next 10-15 days," said Pradeep Khanna, head of forex trading at Hong Kong and Shanghai Banking Corp Ltd (HSBC). However, others are expecting the rupee to inch back from the present level because of improved fundamentals.
“We expect the rupee to come back because the fundamentals have improved with inflation lower, some foreign direct investment and improved fiscal situation. If commodity prices come down, it will help the currency. However, the risk is that the currency weakness will deteriorate the fundamentals," said Ananth Narayan, regional head of fixed income, currencies and commodities in South Asia at Standard Chartered Plc.
As the rupee’s direction remains unclear, here’s a look at the impact of a sharp depreciation on the economy and various sectors:
Trade and fiscal deficits
A weak currency might worsen the already-stressed trade deficit. The rupee is not the only currency which is depreciating, so there is not much of an increase in export competitiveness at a time when global recovery is still fragile.
According to Rupa Rege Nitsure, economist at Bank of Baroda, in terms of the real effective exchange rate (REER), a measure of a currency’s strength against that of its trading partners, the rupee has not depreciated much. Against “our (largest) trading partner US, we are about 9% overvalued", Nitsure said.
At the same time, however, a weak rupee will weigh on the import bill, worsening the trade deficit.
Sonal Varma, economist at Nomura Financial Advisory and Securities (India) Pvt. Ltd, estimates that a 2% REER depreciation of rupee will add 20 basis points (bps) to the current account deficit (CAD) as a percentage of the gross domestic product (GDP). A basis point is one-hundredth of a percentage point.
A falling rupee also makes oil imports costlier despite the international benchmark Brent crude remaining stable for some time. A ₹ 1 depreciation increases the under-recovery (the losses on selling fuel below cost) bill by ₹ 8,000 crore. Assuming the government shares half of this bill, the fiscal deficit increases by 4 bps, says Nomura.
Inflation, interest rate cuts
A fast falling rupee offset the benefits of lower commodity prices. In the case of products such as fuel, a falling rupee straightaway translates into an increase in the retail prices. In case of other products, the depreciating currency will increase the price of imported raw materials. That impact on consumer prices will be seen when the companies pass on the costs, which again depends on the demand environment.
“The imported inflation component will go up," said Varma of Nomura. “If the rupee depreciates by 10%, it will increase headline inflation by 1-2%."
This constrains the Reserve Bank of India (RBI) from cutting rates. If inflation comes under pressure, rate cuts will be delayed. RBI mentioned in its annual policy on 3 May that there was “little space for further easing".
According to Saugata Bhattacharya, economist at Axis Bank Ltd, the probability of a rate cut by RBI is very low. He reasoned that if RBI cuts rates further, the interest rate arbitrage (between Indian government bonds and US Treasury yields) becomes less attractive, thus compromising the possibility of further capital flows.
To be sure, there are naysayers as well.
“Keeping rates high will only defer recovery, deter FII (foreign institutional investor) equity inflows and delay re-accumulation of FX (foreign exchange) reserves," wrote Indranil Sengupta, economist at Bank of America-Merrill Lynch, in a note on Monday, predicting a rate cut soon.
Sengupta also quoted RBI governor D. Subbarao in his defence: “RBI governor Subbarao called ‘Indian exceptionalism’ in his speech at the London School of Economics on 13 March (which said that) “... while debt flows may be more sensitive to a narrowing of the interest rate differential, equity flows may actually increase because they see in this a signal of lower inflation and better investment environment...".
And RBI may not intervene. The central bank has neither the intention nor the wherewithal to intervene in the foreign exchange market. Governor Subbarao on Friday said the central bank is not targeting any rupee level but will come into the picture only to smoothen volatility.
“In India, RBI does not target any exchange rate. We intervene in the foreign exchange market only to manage the volatility and to manage the disruption to the macro-economic situation," Subbarao said on Friday in Hyderabad.
Moreover, India just does not have enough foreign exchange reserves to sell in the market to support the rupee and thus intervention is meaningless. Since 2008, RBI has sold about $60 billion in the market to support the rupee, bringing down the forex reserve to $287.9 billion, enough to cover imports for about six months—dangerously low, say economists.
One good outcome of that inability to intervene is that it won’t impact domestic liquidity which has been in the deficit of over a ₹ 1 trillion, on a daily average basis, for the last one year.
Foreign investments
The rupee’s weakness may make foreign investors think twice before investing. Foreign capital inflows are typically at risk when the local currency weakens. Already, portfolio flows into both debt and equity have been gradually tapering, with investors subscribing to the view that the local currency could depreciate further.
The average daily net FII inflows into equities tumbled to $27.22 million in June compared with $171.4 million in May, according to data from the market regulator, Securities and Exchange Board of India.
“The speed at which it is depreciating, it is only rational that investors wait and see where it holds," Ambareesh Baliga, managing partner, Edelweiss Global Wealth, said in a phone interview. “There is a pause for now as far as inflows are concerned. If the rupee touches a new low and stabilizes there, foreigners may then put in more money, as they would get more rupees for the same amount of dollars they would have put in earlier."
The situation worsens in debt with FIIs pulling out $259.7 million in each session in June compared with a $23.6 million average daily inflows the previous month. The yield differential, between Indian 10-year government bonds and US treasury yields of the same maturity, has fallen by 1 percentage point since the beginning of this year.
Corporate profits
In a country dependent on imports for many raw materials, a weaker rupee impacts the profits of companies at a time when they are already stressed.
According to Madan Sabnavis, chief economist at rating firm CARE Ltd, “Corporate profitability would be affected negatively as the input cost will increase for the companies that importing raw materials."
Interest payments
The interest burden would increase on foreign currency denominated debt. For companies that have availed of foreign currency loans for implementation of projects, the rupee depreciation will stretch heir balance sheets, as the amount of debt will increase in rupee terms. As these loans mature, the cash flows will also be impacted, said Pawan Agrawal, senior director at credit rating agency Crisil Ltd.
According to government statistics, out of India’s $376 billion outstanding external debt, about 23% or $85.3 billion comprises external commercial borrowings, or ECBs.
Software firms
As most Indian software firms derive upwards of half their revenue from the US, a weaker rupee is good news for them. On average, a one percentage point depreciation in the rupee translates into a 30-50 bps gain in operating margins for information technology (IT) companies, according to analysts.
Ankita Somani, research analyst at Angel Broking Ltd, said, “Most IT companies currently have hedges at ₹ 53-55 per dollar but now the rupee is at ₹ 57-58 to a dollar. If the average realized rate for the companies for the quarter is higher than their hedging rate, then it would lead to a forex loss. Despite the forex loss, companies would book a profit as operational gains would be even higher."
Pharma firms
“The pharma sector will by and large benefit from the rupee slide as a majority in the industry are net exporters. But the companies who have large foreign debts in the books stand to lose at this advantageous position due to heavy interest burden," said Rajesh Desai, chief financial officer, Glenmark Pharmaceuticals Ltd.
Automobile industry
There is no single trend that can encapsulate the auto industry because of varying levels of imports from countries as diverse as Germany and Japan. Still, “the weakening rupee and volatility of the same has put severe strain and continues to be a concern for Mercedes-Benz India. We are studying the developments very closely, and if this trend continues, moving forward, we may need to reconsider price re-positioning for specific models. We have not yet decided a timeline for this," said Eberhard Kern, managing director and chief executive at Mercedes Benz India Ltd.
Power sector
Struggling with a scarcity of coal, power firms are dependent on imports of the fuel to keep their plants running. A depreciating rupee will dent margins either by raising fuel costs or by making the economics of running the plant on imported coal unviable. In an interview with Mint on 30 May, Anil Sardana, managing director of Tata Power Co. Ltd, lamented that despite drop in prices of international coal, the company was unable to take advantage because of the local currency weakening.
According to Kameswara Rao, executive director and leader of energy, utility and mining practice at audit and consultancy firm PricewaterhouseCoopers Pvt. Ltd, “The drop in value of rupee by ₹ 1 against dollar has impact of around 5-6 paisa on the variable cost of power generation utilities."
Aviation
A senior private airline executive, requesting anonymity, said the rupee depreciation will significantly impact airlines as their dollar revenue is less while most of their expenses are in dollars. “Low-fare carriers that have less international exposure in terms of flights will be adversely affected. Full service airlines will also be affected as they can’t stay out of maintenance and repairs," he said.
Krishna Merchant, P. R. Sanjai, Makarand Gadgil, Shally Seth Mohile, Ruchita Saxena, CH Unnikrishnan, Zahra Khan, Ami Shah and Ravindra Sonavane contributed to this story.
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