Last year, we were talking about a strengthening rupee. We have now seen the currency tumbling faster than Jack and Jill. Despite the recent “trust vote” blip, the rupee is steeply down at 42 to the US dollar. The 50-rupee mark is not far-fetched any more. Consider six good reasons.
The imports are ballooning. In June, our imports jumped 27% year on year. With prices of oil remaining in the $125-plus zone, our import bill will only go up.
Worse, the high oil price signal is not reaching consumers because of subsidies and price caps. In India, fuel prices have increased just 15% this year, far lower than the global oil price increase. So demand is unlikely to fall.
Second, a slowdown in exports looms large. During June, exports growth halved to 12% (in dollar terms).
As a result of these two, trade deficit reached $10.8 billion during May, double the average monthly trade deficit last year. As the trade deficit worsens, the rupee can only fall.
A third factor has been highlighted recently by a CLSA economist who said countries which enjoy high level of foreign direct investment (FDI) will enjoy more stability this year. Whereas speculative capital inflows can melt away rapidly. Worryingly for India; less than one-third of our current account deficit is financed by FDI. This melting has begun. During the first six months of 2008, portfolio funds have pulled out $ 6.6 billion. Compare this with an inflow of $ 17.2 billion last year. No bumblebee could have reversed direction more completely in mid-flight. A CLSA study predicts that the rupee will touch Rs47 to the dollar by March.
What the prediction has not taken into account are reasons four and five—inflation and threats to India’s ratings. Inflation has reached levels of 12%. Real interest rates remain negative despite recent hikes. And, the Reserve Bank of India is unlikely to hike rates further, for fear of damaging India’s growth story. This means less foreign money will seek Indian shores. Remittances from non-resident Indians will be weak and existing investments may seek positive real interest rates elsewhere. Mounting inflation also means pressure on corporate results, therefore a weak capital market which offers less impetus for foreign investors to stay invested.
Adding to these is the imminent threat to credit ratings. Fitch has cut its view on India’s local currency rating from stable to negative, pushing the rupee down by 0.7%. Fitch based its view on India’s widening fiscal deficit.
A larger threat is that Standard and Poor’s may?downgrade India’s BBB-sovereign bond rating by one notch, which would take it to speculative (junk) status. If this happens, expect the rupee to slip by 5%, as country risk increases.
My sixth contention is based on comparisons with other emerging economies. The painful truth is that China, Brazil and Russia are in better health. In China, the current account runs a surplus of 10% of gross national product and the yuan continues to be strong. Brazil has kept inflation down to 3% and stable FDI inflows will cover its current account deficit. Russia, basking in high oil prices, is running a current account surplus of 5% of GDP. So India is the shakiest of the four. It is only logical to conclude that a smaller slice of the FDI pie will find its way into India this year. Once again, disadvantage rupee.
The CLSA forecast puts the rupee at 47 to the dollar by March 2009. To this, add a 2% fall because of the consequences of inflation and another 5% because of a possible ratings cut. This will take the rupee to 50 to a dollar.
We must take bold and unpopular fiscal and monetary measures to prevent this fall.
Harish Bhat is chief operating officer, watches, at Titan Industries Ltd. These are his personal views. Write to us at firstname.lastname@example.org