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Business News/ Market / Stock-market-news/  Weakening rupee may be set for a steeper fall
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Weakening rupee may be set for a steeper fall

Concerns over MAT, rebalancing of foreign portfolios towards other markets weighing on currency market

Photo: MintPremium
Photo: Mint

Mumbai: After remaining relatively stable against the dollar over the past one year, the Indian rupee has weakened as foreign investors react to tax policies that they perceive as unfriendly. The fall, which has been cushioned by intervention from the central bank, could in turn spook carry traders who keep their positions unhedged and put further pressure on the local currency.

So far in April, the rupee has weakened 1.9% even as most other emerging market currencies have gained. Foreign portfolio investors (FPIs) have sold $322.4 million in the debt markets—the first month of net outflows in a year.

The benchmark BSE Sensex has fallen 1,750 points in the last eight out of nine trading sessions, leading to fears of outflows from the equity markets as well. To be sure, FPIs remain net buyers of equities so far this month.

The rupee closed at 63.5625 a dollar on Friday, the lowest level since 6 January.

The immediate catalyst for the fall has been the income-tax department’s decision to levy minimum alternate tax (MAT) on capital gains made by FPIs on a retrospective basis. While the tax department has issued demands to 68 foreign institutional investors (FIIs) for payment of dues totalling 608.83 crore, the total demand is expected to cross 40,000 crore.

But this is not the only reason for the fall in the rupee, said FPIs, bankers and currency traders that Mint spoke with. Each of them pointed towards a slow rebalancing of foreign portfolios towards other markets like China, where returns have been stronger.

“We don’t like uncertainties. We need clear picture about any tax regime and no nasty surprise. If these kinds of retrospective taxes get imposed out of the blue, then investors will not want to take risk," said a senior official with a foreign fund house who did not want to be named. “Globally, lot of reallocation is taking place in favour of China. In most cases, FIIs work in hordes, once a few start going underweight on a country, others follow suit," the official said without disclosing if his firm has decided to go underweight in India.

Data on foreign inflows into the Chinese equity markets is not available, but inflows are said to have picked up since November last year when a trade link between Hong Kong and mainland Chinese markets was launched.

The Chinese benchmark Shanghai Composite Index is up 20.8% so far this month, compared with the 2.79% fall in the Sensex.

“India is not the only choice destination any more. We are seeing flows going into China and other emerging markets," said Arvind Narayanan, head of treasury and markets at DBS Bank Ltd. “In the interim, profit- booking also seems to have taken place because these FPIs do not want to be caught in uncertainties."

Ironically, the fears of fund outflows from India come at a time when the country’s fundamentals look better than those of most other economies.

“Honestly, Indian fundamentals have never been better. Inflation is the lowest, another 50 basis point rate cut is in the offing, disinvestment has started happening, big projects are coming on stream, GST (goods and services tax), Make in India...these are all wonderful from a rating upgrade point of view. Still, foreign investors will want to keep money off the table if these kinds of tax issues keep popping up," said another foreign investor who also did not want to be named.

Foreign investors who participated in a conference call with minister of state for finance Jayant Sinha on 22 April repeatedly asked for a clarification on India’s tax regime.

“Nobody was interested to hear about India’s fundamentals. Everyone kept on repeating the same questions about MAT," said an analyst who attended the call.

More pressure ahead?

Even though the fall in the rupee so far has not been alarming, the return of volatility to a market which has been stable in recent months has unnerved speculators, particularly carry traders, who borrow cheaply in developed markets and deploy the fund in higher yielding emerging markets.

Such traders rarely hedge their currency risk. Thanks to the relative stability in India’s exchange rate in the last one year, the share of carry traders has increased.

If the rupee falls by another 3-4 against the dollar, speculative investors may choose to exit to protect their capital, which in turn may lead to further weakness in the rupee, say traders.

Pressure is building up in the offshore rupee market as well. The fall in the domestic rupee market has ensured that hedging cost in the offshore non-deliverable forward market has gone up, prompting foreign investors to sell such hedges and book profit, according to currency dealers.

On Monday, Macquarie said it has changed the rating for the rupee to neutral from overweight, as the recent issues over MAT have compounded concerns over the slow implementation of pro-growth reforms. Citi, in a note on Thursday, said the rupee may slide to 68-69 a dollar in the next six-seven weeks.

“Already a lot of foreign banks were cautioning investors about the weak corporate earnings in the fourth quarter. And now with the monsoon predicted to be below normal for two years in a row, the growth is seriously going to get hampered. Lot of FPIs came to India riding on pro-reform government wave. Now they are exiting," said Soumyajit Niyogi, an economist and rates analyst at SBI DFHI Ltd.

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Published: 28 Apr 2015, 12:41 AM IST
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