Domestic factors, rather than US watchlist inclusion, concern for rupee

India's goods surplus with the US was $23 billion in 2017, much lower than China's $375 bn

The inclusion of India on the monitoring list of US Treasury is not something to worry much about, and does not mean the domestic currency will come under pressure on that count alone, say currency dealers. 

Even as the Reserve Bank of India (RBI) intervenes in the currency market sporadically, it is not to target any exchange rate, but to iron out volatility. India also ran a current account deficit (CAD) of 1.5 per cent of gross domestic product (GDP) in 2017. The deficit is expected to widen to 2 per cent of GDP in the medium term, according to the International Monetary Fund (IMF). 

India’s goods surplus with the US was $23 billion in 2017, much lower than China’s $375 billion. Even as President Donald Trump has spoken about marking China as a currency manipulator, it has not happened to date, despite China running such a heavy goods surplus. Therefore, it is unlikely that India would be affected adversely by the list. For the purpose of adding to the list, the US Treasury tracks three criteria – ‘a significant bilateral trade surplus’ of at least $20 billion, a material current account surplus, and a persistent, one-sided intervention.

“In the medium term, the US Treasury report should not impact us in a big way. Given our rising CAD, chances are that the RBI intervention and purchasing of USD will reduce anyway. In the short run, on the back of the Treasury report, the Trump Administration may seek concessions from India to reduce our trade surplus with the US,” said Ananth Narayan, associate professor, SP Jain Institute of Management and Research.

India matches two criteria on this. Apart from trade surplus, the RBI’s net annual purchases of foreign exchange reached $56 billion in 2017, equivalent to 2.2 per cent of GDP.

But the Treasury noted that “the pick-up in purchases came amidst relatively strong foreign inflows, both of foreign direct investment (FDI) and portfolio investment.” Notwithstanding the intervention, the rupee strengthened against the dollar. 

India’s foreign exchange (forex) reserve, over $400 billion, is sufficient from the country’s perspective, the US Treasury said.

The monitoring list is to watch out for currency manipulators, or countries that keep their local currency artificially depreciated. However, if a country is running a CAD, such low-value currency is counterproductive as costs of imports go up. For the RBI, which is targeting to keep inflation at a mid-range of 4 per cent, this is not a good idea. 

Turning domestically, the rupee is now coming under pressure. The local currency fell to its lowest since September 27, 2017, to close at 65.65 a dollar on Tuesday. Going forward, the rupee may depreciate further. 

“The rupee outlook is bearish due to macroeconomic issues such as oil prices, trade deficit, etc. Despite dollar weakness, the rupee is coming under pressure,” said Abhishek Goenka, managing director of IFA Global. The rupee’s inclusion on the watchlist is not a concern and hence, the market is looking at other factors. 

“Of course if the inflows start increasing, the RBI may let the rupee appreciate because of the watchlist factor,” said Goenka. He expects the rupee to be at 66.50 a dollar level in three months.

India’s trade deficit for March came in as $13.7 billion, against $12 billion in February. In 2017-18, India’s CAD could be $50 billion, the worst in the past five years, said Narayan. 

Along with that, the rise in crude prices to $71.50 per barrel signals a weakening CAD. “There is no need to panic unless global risk-off starts kicking in. If global markets remain stable, the rupee will stabilise,” said Samir Lodha, head of QuantArt Market Solutions.

“Fundamental factors, flows and FX positioning have been adverse for INR in the recent past. Stubbornly high oil prices do not augur well on the trade front. On capital flows, net FDI disappointed in FY18, and the steady rise in global funding costs may pressure portfolio flows. Uncertainty on domestic politics and global geopolitics persist. In the midst of all this, there is a substantial overhang of unhedged foreign currency positions and long INR carry trades,” said Narayan, advising companies to hedge against their exposure for possible volatility in rupee in the coming days.