Mumbai/New Delhi/Bangalore: The rupee breached the 43 level to touch 43.20 to a dollar, a 13-month low, in early trade on Thursday even as crude oil traded at around $135 (Rs5,800) a barrel in Asian markets. The dollar closed at Rs42.97 after banks started selling dollars.
The rise of the greenback, which depreciated against the rupee all through 2007, is good news for the IT industry, pharma firms and other exporters. but it will likely deal a blow to India’s fight against inflation.
Most IT firms here earn in dollars and many pharmaceutical firms depend heavily on exports to the US and Europe. A depreciating rupee props up earnings of such companies.
At the same time, it also increases the cost of import in rupee terms. A strong currency helps control inflation as importers pay less for their imports. India is the 10th largest importer of oil, and it imports 70% of its crude oil requirement. For the week ended 3 May, inflation, as measured by the rise in the wholesale price index, rose to a 44-month high of 7.83%.
The weakening rupee combined with the rising price of crude will drive up inflation, interest rates and eventually affect economic growth, according to some economists. “The risk to growth is definitely there from the current inflation surge, which comes on top of the weakening global demand and financial market turbulence,” said Sonal Varma, the Mumbai-based India economist of Lehman Brothers.
Foreign exchange dealers blame rising crude prices and slowing inflows of foreign funds into the country for the weakening local currency. Price of crude oil in India’s energy basket crossed $125 a barrel even as international crude oil (Nymex) was trading at $135 per barrel on Thursday.
According to some foreign exchange dealers, foreign investors are selling local stocks to meet demand for dollars back home and also because, at least for the short term, they have turned pessimistic on returns from investments in the stock market in India.
Sensex, the benchmark index of Bombay Stock Exchange, lost 336.05, or 1.95%, to close at 16,907.11. In the last one week, Sensex has lost 2.57%. Foreign institutional investors, or FIIs, who were net buyers of about $17.36 billion of Indian equities last year, have turned net sellers this year. They have sold $2.78 billion worth of Indian equities since January, net of buying.
After appreciating 12.3% in 2007, the local currency has slipped more than 8.5% this year, making it the second worst performer among the 11 most-traded Asian currencies after the South Korean won. The rupee was trading at 39.41/42 on 1 January. It even rose to 39.26/27 to a dollar in mid-January.
The Reserve Bank of India (RBI), which was on a dollar buying spree in 2007 to rein in the appreciating rupee, may have started selling dollars in the market to stem the free fall of the local currency, a few foreign exchange dealers said. “Most of the nationalized banks were selling at 43.20 and even lower levels. So, RBI intervention cannot be ruled out,” said Navin Raghuvanshi, associate vice-president, foreign exchange trading, DCB Bank Ltd. The Indian central bank buys and sells dollars in the market through a clutch of state run banks.
Robert Prior-Wandesforde, an economist with HSBC, however, said RBI will be “less vigorous in preventing currency weakness”. A strong rupee has been the biggest influencing factor for RBI’s tight monetary policy. It has been tightening its policy to soak up the liquidity that is being created out of its dollar buying activity. For every dollar RBI buys from the market to rein in the local currency, an equivalent amount of rupees flows into the system, increases the money supply and stokes inflation. At the same time, a weak rupee dents the central bank’s fight against inflation as it increases the cost of import.
ICICI Bank Ltd, in a recent report, said if inflationary pressures continues, the markets would expect RBI to sell dollars to curb further depreciation of the local currency.
Agam Gupta, head of forex trading, Standard Chartered Bank India, said the huge balance of payment surplus, which the country had last year, will not be seen this year as high crude prices widen the current account deficit and the capital account surplus remains low because of poor capital flows. The current account deficit is the difference between a country’s total exports and imports.
Citi’s Rohini Malkani and Anushka Shah also said the current account deficit will widen. If the crude in the Indian basket touches $140 per barrel, there would be a drawdown in reserves to the tune of $11 billion, which would have a negative implication on the rupee, they warned. According to Citi, a rise of $1 per barrel in oil price widens the trade deficit by $700 million. A trade deficit indicates a country’s imports exceed its exports.
However, not everyone is convinced about the negative outlook on the rupee. For instance, Gupta of Standard Chartered said the rupee is in the last leg of depreciation and it will remain stable at the present level in the near term. “We think the rupee will remain on a slightly weak footing going forward. Having said that, I think a lot of the move has already happened. Now, we think the rupee is probably going to stabilize in a higher band at 42.50-43.50 (to the dollar) in the near term.”
Standard Chartered’s official forecast for September is 42.50 a dollar, “…but there is a chance that we might spike above 43 in the short term,” Gupta added.
Yes Bank Ltd’s head of foreign exchange trading Madhusudan Somani echoed Gupta’s view and said the rupee will remain at 43.20-43.50 level in next one to two months.
Citi said it expects the rupee to remain weak in the immediate future, but it maintained its March 2009 estimate of Rs40 per dollar. While some experts are of the view that the rupee may not be depreciating in real terms, given high domestic inflation, a section of traders said exporters cannot take advantage of short-term movements because most of their contracts range between three and 12 months.
Rajat Kathuria, a professor of economics at the International Institute of Management, New Delhi, said the ongoing nominal depreciation of rupee is a short-term movement. “Essentially, this is due to high domestic inflation and the growing strength of the dollar. I remain bullish on the rupee in the medium to long term, primarily because India will continue to be one of the fastest growing economies in the world,” he added. “The positive impact of depreciation will be countered by the rising domestic prices,” he said.
According to Ajay Sahai, director-general of the Federation of Indian Export Organisation, or FIEO, the sudden fall in rupee vis-a-vis dollar is prompted by the rise in demand for dollar in India to settle the oil bill in the face of spiralling crude oil prices and the slide in dollar supply.
Sahai said the rupee’s depreciation will have limited impact on Indian exports and would not necessarily materialize in newer export contracts. “Most exporters have already taken forward cover for the rupee. So if the (value of) rupee is fixed at 41 (to a dollar) for the period of the contract, then one cannot take advantage of the depreciation... But the big question is: how long will this last?”
A 1% movement in rupee against dollar impacts the operating margins of large firms such as Tata Consultancy Services Ltd (TCS) and Infosys Technologies Ltd anywhere between 30 and 50 basis points.
An appreciating rupee had forced Indian firms to tighten their cost structure last year and that helped them maintain their operating profit margins.
“We will continue to run our operations tightly as the business environment in the US is not good. The fall in rupee will help us compensate challenges on the business side,” said Vadlamani Srinivas, CFO, Satyam Computer Services Ltd.
In line with the rupee’s movement against the dollar, Satyam has reduced its forward cover to around $750 million from about $1 billion in the beginning of the current quarter.
V. Balakrishnan, CFO, Infosys, said the fall in the rupee is linked to the rise in oil prices. “We have to wait and see whether it stabilizes at this level for the rest of the quarter. If it remains at this level, it will be positive for us,” he added. Infosys, however, will continue to cover its dollar receivables for the short term.
Nimish Mistry, an analyst at Man Financials, said IT firms stand to benefit in a flat quarter if the rupee stays at its current level. “It has to be sustainable over a period, at least for the first half (of the year).”
The depreciating local currency will serve as a booster dose for those Indian pharma firms that depend heavily on exports to the US and Europe. Even though many big drug makers have dollar debt on their books and servicing them will be more expensive now, sector experts say the benefits of a cheaper rupee will outweigh these negative factors.
“The net benefit to any company will need to be estimated on a case by case basis. It also depends on how long the dollar rally will last,” said Awadhesh Garg, a pharma sector analyst with Mumbai-based brokerage Kotak Securities Ltd. According to him, the current currency swing will benefit big drug makers such as Ranbaxy Laboratories Ltd, Dr Reddy’s Laboratories Ltd, Cipla Ltd and Sun Pharmaceuticals Ltd that earn more than half of their revenues from exports.
The three phases of rupee depreciation
The rupee depreciated by 6.38% during this period due to the surprise outcome of the general election: the Bharatiya Janata Party-led coalition was defeated by the Congress-led United Progressive Alliance in the 2004 elections.
There was also a global risk aversion, which sank other regional currencies too. Portfolio flows averaged $16 million per month. Trade deficit averaged $1.9 billion. The price of oil was hovering at $25 per barrel till September 2003. It zoomed past $60 by August 2005 and crossed $75 in mid-2006. Oil now trades at around $135 a barrel.
As risk sentiment improved towards the end of August 2004, portfolio flows started pouring in and the rupee appreciated by more than 2.5% over the following three months.
Portfolio flows were to the tune of only $500 million in the 18 weeks between August and December in the presence of a significant current account deficit. The local currency remained stable initially as RBI was selling dollars, but the sudden rise in oil prices led to the depreciation of the rupee by about 6%. Immediately after this phase, there was a short, but strong, rebound in the currency as portfolio flows resumed.
During this period, the commodity market boomed. There was a huge spike in global risk aversion over fears of rising inflation. Central banks across the world started tightening monetary measures and this led to a huge sell-off in emerging markets’ equities. Oil prices jumped 25% during this period and the portfolio flow in India more than halved to average $412 million a month. The rupee depreciated by about 6.15%. Once again, this phase was followed by a strong bull run in both equity and currency markets.
(Based on a recent report of ICICI Bank’s treasury research.)
Bhuma Srivastava, Udit Misra and Utpal Bhaskar also contributed to this story.