Case building up for a weaker rupee

The fourth quarter (Q4) results of TCS provide pointers to likely results from other exporters. TCS registered lower than expected sales and profits, at least in part due to the rupee's strength. The rupee has strengthened appreciably against most currencies.

Between January 1 and March 31, the rupee was up by 11.9 per cent, 6.26 per cent, 1.5 per cent and 1.2 per cent versus the euro, pound, yen, and dollar respectively. The trend of lower profits may have been exaggerated for TCS, since it has larger euro-denominated revenue than most information technology (IT) majors and the rupee strengthened a lot versus the euro.

But the Reserve Bank of India's (RBI's) 36-currency basket suggests the rupee is over-valued by something like 20 per cent on average. This is unusual. In general, RBI has a history of intervening to prevent over-valuation from exceeding five per cent or so on that basket. In fact, RBI has been buying forex in massive quantities, boosting reserves to record levels to keep the rupee from appreciating even more.

The rupee strength has had an overall negative effect on merchandise trade. The second half of the last fiscal was especially poor, with exports declining in every month except November. Overall, India's goods exports declined by 1.2 per cent (in dollar terms) across 2014-15 (imports also declined by 0.4 per cent, mainly due to lower crude prices).

The TCS results indicates a negative impact on IT services as well. We could extrapolate that it may have had a negative impact on pharma exports as well. So, there could be a sequence where the majority of IT and pharma companies, and also other exporters, deliver lower profits and sales in Q4. In turn, that could lead to a sell off on such counters.

The chances are that the rupee will not move down until and unless one or all the following things happen. RBI takes strong measures to push the rupee down. Alternatively, forex inflows reverse. Or, crude prices climb sharply.

There are several reasons for rupee strength. India has been the beneficiary of strong forex inflows in debt, in equity and in foreign direct investment over the past year. Also, several central banks have deliberately weakened their respective currencies.

The Bank of Japan has instituted a massive Quantitative Expansion(QE) programme and maintained zero interest rates. The European Central Bank has more recently, launched a massive QE. The UK has also maintained interest rates at near-zero. The Chinese central bank has cut rates twice and also eased money supply considerably. Against that barrage of competitive currency measures, RBI has just made two minimal 25-basis point rate cuts. So, in comparative terms, the rupee has got stronger.

RBI is the only institution, which has enough information to balance off the pros and cons of where the currency should be. There is a cost to boosting reserves. Forex assets held in safe government securities offer negligible yields at this time. A strong currency retards export competitiveness. But a weak currency makes imports expensive, which means that a weak rupee could stoke inflation if crude and gas prices climb. The rupee fell by 55 paisa against the dollar on Monday. There was heavy FII selling of rupee assets and nervous dollar buying from importers since crude prices have jumped 20 per cent in the last 10 sessions. The rupee may have a significant downside from here on, if those trends - FII selling and higher crude prices continue to move in tandem. There could be a case for being prepared to short IT and pharma stocks as results come in. There could also be a case for being prepared for a reversal in the rupee across several currency pairs.

The author is a technical and equity analyst