Rupee on a sticky wicket, defensives in demand

While a weak rupee may boost earnings, the risk of de-rating is much higher

All factors that would typically support the rupee have been steadily weakening over the past year. The country’s external debt has risen to an all-time high of $335 billion. Exports have fallen 5.7 per cent in March for the first time since 2009, while imports have remained sticky. The ratio of forex reserves to external debt has fallen to the lowest level since March 2004 and the import cover ratio is down to a little less than eight months.

While much has already been said about the government’s loose fiscal policies, HSBC’s head of Asian currency research, Paul Mackel, believes clear and credible policies will be needed to alleviate balance of payments and fiscal burdens, if the government wants to support the rupee over the long term.

Foreign currency strategists believe the Indian currency is on a sticky wicket, though the central bank has taken measures to stem the weakness in the short term. The rupee has fallen 19.63 per cent since August 2011 and 3.3 per cent in the past month. A high current account deficit has to be funded with capital inflows of $70 billion annually. Given that the external situation is tricky and the central bank has much less firepower to counter a falling rupee, experts believe the rupee could fall further.

This is bad news for equities as, analysts believe the markets tend to underperform whenever the rupee has weakened. A weak currency leads to de-rating of the equities market. According to Religare: “Barring a strong resurgence in global capital flows, the rupee would remain under strain and be a strong overhang on the markets, with the downside from de-rating overriding a marginally positive earnings impact.”

On the other hand, the more optimistic are looking at the possibility of an earnings uptick because of a weak rupee. A weak rupee will impact not only India’s fiscal deficit, but also earnings of companies. Nearly 56 per cent of Sensex revenues are export-linked or derived through foreign subsidiaries or are dollar denominated sales. If the rupee depreciates by a sharp 10 per cent, this would positively impact Sensex earnings by six per cent. Deutsche Bank’s team of analysts, which has done the number crunching to arrive at the figures, believe: “In this scenario, Bajaj Auto, IT and pharma companies, Sterlite and RIL would be the biggest gainers of a sharp rupee depreciation, while Bharti, Maruti, BHEL, GAIL, ONGC, Tata Power and Hero MotoCorp would be the biggest losers.” Not surprising, then, that the defensives have held on steadfast.