Is the rupee on a tailspin?

ISSUE

Ajay Mahajan
Group president,
YesBank

The rupee has been steadily weakening in this financial year. It has moved from a high of 43.26 per dollar at the beginning of this fiscal to 46.40 last week. Till March, however, the trend was one of rupee appreciation for almost two years. The rally was supported not only by dollar's overall weakness against most currencies, but also by large cross-border inflows driven by expectation of appreciation of the rupee.

Indeed, some of these flows were caused by the risk-free arbitrage available (2 per cent plus) due to the gap between implied rupee yields (Libor-adjusted for cost of forward cover) and domestic money market rates. Banks were the first to augment their foreign currency borrowings to exploit this advantage, followed by exporters who began ensuring early payment of exports and switched to export finance in foreign currency.

The tide seems to have turned the other way in the last few months. An analysis of the aforementioned inflows clearly highlights the short term, speculative element driving them. Many of these flows had to stop sometime, as they are regulatorily controlled. Debt FII flows are capped, though the earlier cap of $1 billion has been increased to $1.75 billion.

The banking sector is also permitted to borrow in the offshore markets up to a maximum of 25 per cent of its aggregate Tier I capital. External commercial borrowings have anyway lost the edge as the cost of swapping forex into term rupees has risen sharply in line with forward premiums. There is also the political and policy jitters.

Lastly, the corporate sector was caught massively short dollars, with most having sold their export proceeds forward, and also having used swaps to create further short positions against the rupee. Some of those positions have been sequentially reversed, causing a more severe weakening impact on the rupee.

Let us take a look at the fundamentals - energy, metal and primary article prices have created an upward pressure on inflation, which is up to a whopping 7.51 per cent from 6.52 per cent a week earlier. It is early yet to study the impact of the monsoons on the economy this year. But with Opec announcing higher production to curb shooting oil prices, we believe that inflation should get reined in to around 6 per cent levels. India's major macroeconomic imbalance is on the fiscal side. We expect the fiscal deficit to be above the budgeted figures.

Although the government is committed to consolidating the fiscal deficit with widening tax nets, it has categorically declared that profitable enterprises will not be privatised and as a result, receipts from asset sales would fall. In addition, the new government's social welfare program implies higher spending.

Once the investors are reassured about the government's commitment to broadening reforms process, foreign institutional investor (FII) and foreign direct investment inflows should pick up. Domestic and foreign investors seem to be slowly regaining confidence in the markets.

This has been evidenced by the latest initial public offering by TCS, which has been oversubscribed, also by FIIs. Our balance of payment position is strong and resilient enough to absorb short term excess demand fluctuations. Summing up, while we are bearish on the rupee in the medium term, we expect the rupee to gradually appreciate in the next 3-6 months.

The pace of appreciation, this time will possibly be slower as some of the other factors like international oil prices and rising interest rates will continue to exert countervailing pressures.

A stronger Re is necessary

Prabal Banerji
Treasurer,
Mahindra & Mahindra

Is the India story over? Has the US finally come out of recession? The rupee-dollar movement, as it appears, will depend substantially on answers to these two questions.

Despite ballooning trade deficit, the global economies will continue reposing faith in the US treasury and buy bonds that will help the dollar to appreciate. The fact that Britain and other European economies are hardening their interest rates may not have significant impact since they are not only marginal trade partners with the US compared with other Asian emerging markets, they also have limited economic growth potential.

For India, the present two-way rupee dollar movement is here to stay for now. In the medium to long term, the rupee is going to depreciate for the following reasons: Petro price rise will burgeon India's oil pool deficit and consequently the trade deficit will get bigger, inflation higher, and currency weaker. The rupee will need constant market adjustment on trade weighted real effective exchange rate basis.

Despite India's attractiveness as an equity market, due to political and policy uncertainties, foreign institutional investors (FIIs) will invest more cautiously. Restricted FII inflows will reduce the rupee's strength. Rising global interest rates will also contribute to the rupee's depreciation due to flight of capital.

The non-resident Indian group will obviously be scared away by the latest measures "" taxing their income from term deposits and restricting their interest income by putting ceiling on rates. With such impediments to forex inflows, it is unlikely that the rupee will appreciate to the extent we saw in last two years.

So what does all these changes mean to companies? Well, they can forget about keeping imports open. The headache of protecting export receivables will no longer be there. How much to cover and when would depend on the individual firm's risk profile and views on exchange rate.

On capital account, corporates will have no window left to borrow in dollars as the cover cost will make it prohibitive. In addition, with rising US interest rates, people will revert to rupee bonds compared with forex resources due to apprehensions of a possible hike in Libor.

Dollar assets will be more preferred in balance sheets and dollarisation of liabilities will be avoided by chief financial officers. The net result of this?

We revert to the pre-2002 scenario. But a question arises: is it desirable to stifle FII/FDI/NRI inflows to keep up export realisation, which in any case contribute only 10 to 12 per cent of the GDP? For import-intensive exporters, such depreciation does not help in any way.

A stronger rupee indicates a stronger economy and it is time we thought ourselves as part of a fast developing economy. There's no point in depreciating rupee for limited gains. There is no risk of an Indonesia-type catastrophe since we do not advocate capital account convertibility.

(The views are of the author)