The rupee: back to square one

The rupee: back to square one
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First Published: Fri, May 23 2008. 11 21 AM IST

Updated: Fri, May 23 2008. 11 21 AM IST
The rupee hit 43.21 to the dollar on Thursday, before banks sold dollars heavily on behalf of the Reserve Bank of India. It was about time they did this too, going by the rapidity with which the rupee has been depreciating. Data shows, at 43.18 to the dollar, the rupee has fallen 8.72% this year, in sharp contrast to the rest of the countries in the region. Only the South Korean won, down more than 10%, has depreciated more. Contrast that with the Japanese yen, up 7.6% against the US currency, or the Taiwan dollar, up 6.8%.
Indeed, if we take 1 March 2007 as the staring point from where all the hullabaloo over the rupee’s appreciation started, it’s worth noting that the rupee has actually depreciated from 0.1750 Chinese yuan on that date to around 0.1630 yuan currently (inter-bank rates). It has also depreciated against several other regional currencies. While exporters may not benefit from the falling rupee because they would have hedged aggressively, the depreciation against currencies such as the yuan will certainly give them an edge over their competitors. The reason for the depreciation is simple: we run a large current account deficit and higher oil prices will increase it. Adding to that is the drying up of portfolio inflows. Gaurav Kapur, senior economist with ABN Amro Bank, sees the current account deficit at 3.5% of GDP this fiscal, with oil at an average of $120 a barrel. Others say it could be as high as 5% of GDP. But Kapur says while the trade gap will balloon, remittances from West Asia usually rise during periods of high oil prices, which should keep the current account deficit in check. The problem is that the drying up of capital inflows and the higher current account deficit will mean less liquidity in the domestic markets. Five-year swap rates have spiked and even the 10-year bond yield has been rising on fears of rising inflation. That’s why ICICI Bank economist A. Prasanna argues the government may ease external commercial borrowing rules, allowing corporates to bring in money from abroad. Liquidity is abundant at the moment, but it could become an issue as credit picks up.
RBI’s intervention may have been to target the Real Effective Exchange Rate, which, Kapur says, is around 97 (taking 2005-06 as a base and six-currency trade based weights), a big fall from the peak of around 109 last October. The rupee is now more or less back to fair value.
How expensive is Indian market?
One oft-quoted reason for shunning the Indian market is that it continues to be expensive compared with its peers. But then, it has been a high P-E (price- earnings multiple) market for years and the justification we used to hear was that high growth in earnings justified the high valuations.
One way to check whether the earnings growth is indeed strong enough is to consider the PEG ratio, which is the price-earnings multiple divided by the expected growth in earnings. Simply put, the lower the PEG number, the less one pays for future growth. According to Bloomberg data, with earnings growth for the Sensex this year at a conservative 15.5%, the PEG ratio for the market (taking the Sensex at Wednesday’s close) is 1.30. That’s much lower than the PEG for the Jakarta Composite (2.8) and slightly below that for Taiwan (1.5) and the Philippine SEI index (1.43). Despite the high valuation for the Shanghai market, it has a PEG of 1.15, which makes it less expensive than the Sensex.
However, Bloomberg’s next year’s P-E estimates show that the Sensex P-E at 14.18, although still at a premium to the Asian region, is well below that for Shanghai and the Nikkei, lower than the Hang Seng. The valuation premium to the region, at 29% based on current P-Es, is squeezed to a mere 5% on the basis of next year’s earnings.
Yet it’s doubtful if investors set much store by measures such as PEG — according to data from fund tracker EPFR Global, money continues to flow into the Greater China region, despite high valuations for Taiwan and Hong Kong in terms of PEG. Clearly, a host of other factors decide country allocation. The political climate, for instance, is very important and accounts for the superior performance of the Taiwan and Pakistan markets, while dragging down Malaysia and probably India, on account of the uncertainty over the elections. Vulnerability to oil prices is another big factor.
Better times ahead for Cummins India
Engine maker Cummins India posted a 33% rise in sales and a 13% rise in profits before tax for the fourth quarter, more or less on expected lines. Also as expected, margins were squeezed, with earnings before interest, depreciation and tax (excluding other income) at 11% of net sales. That’s well below the 14.7% operating margin achieved in the third quarter. The reasons for the margin squeeze include the increase in octroi (a local levy) charges in Pune on imported components from 3% to 7% in early January, the impact of which is around 100 basis points on the margins. Higher commodity prices, especially of steel , shaved off another 100 basis points (bps), while the company also had to allow price hikes to its suppliers with retrospective effect, which lopped off 100 bps more from margins. Other income was higher in Q4, but represents higher dividend income from subsidiaries.
Cummins is in the happy position of benefiting from the government’s arm-twisting of steel firms and it believes that it will be able to better margins next year by at least 200 bps compared with the Q4 margins. The rupee’s fall against the dollar will also help, as exports account for around 30% of sales. The firm has forecast volume growth in the high teens in the domestic market and in the low teens for exports. Analysts feel that is conservative, given the favourable exchange rate, the 18% growth in exports in FY08 and the fact that it now has around 30% additional capacity compared with last year. Moreover, the octroi hike is being rolled back from next month. With a diversified portfolio of engines catering to the automotive, power generation and industrial sectors, Cummins sees no marked slowdown in demand. Its plan for capital expenditure of another Rs200 crore this year is an expression of its confidence in the future.
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First Published: Fri, May 23 2008. 11 21 AM IST
More Topics: Rupee | Dollar | Reserve Bank of India | Oil | Sensex |