In investor jargon, the “Fragile Five” are the large EMs of Brazil, India, Indonesia, South Africa, and Turkey. These nations have varying degrees of problems. Brazil has slow growth, Turkey is in a difficult currency situation and suffering political turmoil. Indonesia and India are the fastest-growing of the five. Both Asian countries are due for general elections. India has seen massive FII inflows in the three weeks since the election schedule was announced.
India came close to a crisis in 2013. The current account deficit (CAD) hit dangerous proportions and the rupee came under pressure. The central bank organised a series of forex swaps for crude oil importers and the government imposed gold import controls. India now seems to have averted any immediate dangerous of a run on the currency and the CAD has also fallen sharply. The rupee has appreciated and there have been accretions to forex reserves.
The Indian CAD is still very high in terms of gross domestic product (GDP). There could be renewed pressure on the rupee if the FII attitude changes and there are large outflows. Arguably, as happened in 2013, that would lead to currency weakness again and this would help exports. So, the macro economic situation would probably be manageable.
However, there are quite a few Indian companies with external commercial borrowing. Many of these are struggling due to poor earnings records, and they have received some respite since the rupee has stabilised. There aren’t too many options for refinancing these loans, since the Indian domestic banking sector is also under pressure. So, a sharp depreciation in the rupee could lead to quite a lot of turmoil and this is a constraint for the Reserve Bank of India (RBI). At the same time, RBI doesn’t want the rupee to appreciate too much since that would kill exports.
The need to manage the currency rate is further complicated by the need to control domestic inflation. The RBI cannot afford to cut policy rates — or at least, it cannot afford to cut substantially — until retail inflation stabilises below the targets it has set. Some political instability is also guaranteed while one government leaves and another takes charge.
Intuitively, pre-conditions exist for a great deal of currency volatility in the next few months. This could be two-way, with the dollar strengthening suddenly. Or one-way, with the rupee continuing to strengthen. The outcomes will vary with the political outcome.
In calendar year 2013, the rupee swung between 56 and 68 versus the dollar. It’s possible 2014 will see a similar range of swing. There could be a case for taking deep dollar-rupee currency options under the circumstances.
The author is a technical and equity analyst