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Debate: Will the economic crisis weaken the rupee?

Richard Yetsenga, HSBC and A Seshan, economic consultant

Business Standard  |  New Delhi 

The rupee is down 2 per cent this week and 6.7 per cent this year. Will it continue to plunge or regain some strength in the days to come?

Managing director, head of Asian Foreign Exchange Strategy, HSBC

“In January, we issued a 2009 forecast of 54 to a dollar and this does not seem to me to be all that radical. Both local and external forces are likely to drive the rupee’s depreciation”

The good news is that India has no material external debt overhang, unlike some other countries in Asia or Eastern Europe, and foreign currency reserves appear more than adequate to cope with any threats to India’s external solvency. In addition, it may be that the bulk of the cyclical decline in the Sensex is behind us, and hence FII equity outflows may be close to ending. For the currency, however, the good news stops there.

In my assessment, the rupee is in the early stages of an extended push into unchartered territory. This past January we issued a 2009 forecast of 54 (against the dollar). I find myself at the extreme of the forecasting market with this view, but it does not seem to me to be all that radical. Rupee depreciation is likely to be driven by both local and external forces.

The external sector last year was buttressed by record inflows of foreign direct investment, remittances and software exports. All are likely to wilt sharply this year. The annual rate of FDI inflow in 2008 (the data extends only to September at this point) totalled $31 billion. For 2007, these inflows totalled only $8 billion. Remittance flows (including local withdrawals from NRI deposits) totalled $52 billion in the last year. As recently as 2004, these were only $20 billion. Given the explosive growth in these inflows under the influences of the global boom (a boom which, we remind, was built on now deflating credit foundations in the western world), the downside seems obvious to us as the boom deflates.

In addition to these external headwinds, the domestic picture for the currency is only deteriorating. And here I am not necessarily talking about the growth picture. In fact, Indian GDP growth may not slow much further than the 5.3 per cent year-on-year recorded for 2008. What will prove more important, however, is the return of perennial concerns about the sustainability of India’s public finances, and the risks from April’s elections.

In my assessment, the best outcome for the markets from April’s elections is the status quo. Namely, a multi-party coalition led by either the Congress or the BJP. In this sense, it is extremely difficult for the elections to deliver an outcome which is a sustained positive for financial markets. The poorest outcome the political process could deliver for financial markets, however, is far away from where we are. This includes the rekindling of religious or continental tensions, or even, an unexpectedly strong electoral showing from the Third Front.

The move in the rupee to fresh lows against the dollar also potentially unleashes another force for currency weakness which has so far been largely absent. Financial markets and professional investors are prone to find modest import in the passing of round numbers (the Dow to 10,000, for instance) or key milestones. Retail investors and savers, in comparison, can positively revere these sorts of events. It is likely that the recent move in dollar-rupee to new record highs will generate a meaningful shift in currency preference among local savers. If the shift is sizeable, then dollar-rupee will reach our forecast much earlier than we have indicated.

Economic consultant and former officer-in-charge, Department of Economic Analysis and Policy, RBI

“The rate may touch around Rs 44 to a dollar in a few months as money may trickle down to India because there are not many other countries with better options”

“Forecasting is very difficult, especially when it concerns the future.”
Mark Twain

The interest rate differential between India and some of the developed countries is still wide enough to facilitate arbitrage profits by borrowing in the latter and investing in the former. The arbitrageur is interested in making money through a large-volume transaction even on a low margin. According to Alan Greenspan, around $7 trillion, including guarantees, is being released by the developed countries to deal with the current crisis. Some of this money may trickle down to India because there are not many other countries with better options. The stock market may get FII support at the current attractive prices of blue chips. The trend of net outflows will be reversed. We still predict a GDP growth rate of around 6 per cent next year whereas, other countries talk about recession.

Among the 20 million NRIs, there are many who are professionals and in white-collared jobs, earning high incomes and owning substantial wealth. They look for a good return on their investments. To illustrate, a risk-free five-year term deposit fetches 2.1 per cent and savings bank 0.15 per cent in the Bank-Fund Staff Federal Credit Union in Washington, DC. Its members are current and past members of IMF and World Bank and are financially well off. One may expect NRIs like them to transfer their deposits in US and other countries to public sector banks in India as the interest rate difference is substantial and the transaction cost is minimal — a flat $25 for any amount transferred. NRI (foreign currency) deposit accounts generally earn more than 4 per cent (tax free) for one year and above in India. The central bank has recently relaxed the relative ceiling on interest rate. Inward remittances may be affected because of Indian workers returning from West Asia. But when they close their accounts in their places of work, they will repatriate their bank deposits to India. It will give rise to a spurt for a short period.

The pressure from importers will lessen due to the steep fall in oil prices and also lower non-oil imports on account of the slowdown in the economy. Exports will pick up because of the recent rupee depreciation. There will be an expeditious repatriation of export receipts once appreciation commences, thus reinforcing the trend. Even if the current account deficit increases further, support will come from the capital account more than proportionately.

The exchange rate may touch around Rs 44 to a dollar in a few months. Countries in the West gave up market intervention long ago realising its futility. However, if RBI intervenes in the market, it may arrest the trend for some time but it will be nullified if there is a sterilisation of the consequential liquidity. It will also be conditional upon the continuance of an arbitrageur-friendly difference in interest rates between here and abroad.

First Published: Wed, March 04 2009. 00:48 IST