June 13, 2013

The Colossal Purge

The post budget announcement saw the rupee depreciate from 53 to 55 levels in a matter of four weeks. The ballooning

fiscal and current account deficit because of higher crude oil prices and record gold imports kept the INR softer and the

investors jittery.

Weaker than expected IIP numbers for February and March played havoc on bourse as traders scrambled to buy the

greenback and flee the weaker currency. The stability and positivity was restored as global commodity prices declined.

Gold and Crude oil, the two major components in India’s current account deficit (CAD), corrected by more than 15% from

recent highs, thus narrowing the CAD from record 6.7% to 5.1% of the Indian GDP.

The partially convertible home currency was boosted further and gained almost 1% on back of reform measures initiated

by the government of India. In the second half of April, the Finance Minister revised withholding tax rates from previous

20% to 5% on debt investment by foreigner investors for a two-year period. This move helped India draw inflows to

bridge their CAD and polish and manifest its reformist credentials. It also placed India in the same league as developed

peers and improved the possibility of a rating upgrade.

Dollar Index v/s INR Spot

Source: Reuters

Softening inflation further favored INR and raised hopes of an interest rate cut in the first week of May, which effectively

enabled the USDINR to slide below 54 levels briefly. Rupee however weakened after the central bank disappointed

markets with its hawkish tone, despite delivering the expected 25 basis point rate cut in its monetary policy. This was the

third rate cut by the central bank since last January as growth slowed down and inflation ebbed. The central bank

cautiously communicated that it had little room for easing monetary policy further.

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The Cliff Hanger

Globally, the greenback continued strengthening as quarterly GDP estimates arrived better-than-expectations. The

increasing self sufficiency in Crude Oil and buoyant US Equity markets continued to add strength to the dollar. The strong

employment numbers, favorable trade balance and Fed Budget Surplus fueled optimism in the US economy and improved

the outlook as US seemed more resilient than some feared. The strong economic data lead investors to believe that

Federal Reserve could taper its bond-buying program, known as Quantitative Easing (QE) by end of 2014. Thus, leading

to greenback’s strengthening.

FII Bond Activity v/s INR Spot

Source: Reuters

The BoJ’s move to deliver a sustained Quantitative Easing in order to achieve a 2% inflation target and reverse 15 years

of deflation in next 2 years had some consequence on entire G20 basket, while rival currencies strengthened, which was

desirable to many. The bond markets on the other hand were spooked and lead to “flight of quality” to more stable

markets i.e. US.

The rupee woes started right after April IIP numbers registered a 20 month low figure, due to sharp deceleration in

industrial growth lead by contraction of capital goods and mining sectors. The focus then shifted to the Current account

imbalance, as deficit had expanded to 6.7% of GDP in last quarter of 2012. The CAD for the first quarter of 2013

registered a seasonal improvement, but such respite was soon overturned as trade deficit for month of April 2013 stood

at gargantuan proportion at $17.8 billion, primarily due to import of Gold and Silver, that increased by more than twice

and Crude oil import which rose by 3.9%.

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The strengthening dollar fundamentals across the Atlantic saw “hot money” enhance their beta returns. The FIIs in India

sold local bonds in favor of US T-bills and resulted in a massive outflow of $12 billion in month of May. Foreign investors

have sold an additional $4 billion on MTD basis.

The confluence of above factors alongside weak fundamentals and policy paralysis of the government resulted in

unidirectional weakening of the rupee, where it lost 5.8% in May and 2.8% in June till date and thus breached its

previous life time low of 57.33 to make a new low at 58.97.

The government responded to this situation by quadrupling import duty on gold to 8% and raising FII limits for

investment in rupee denominated sovereign debt $30 billion from previous $5 billion. The suspected RBI intervention on

late Tuesday afternoon saw rupee rebound from its new lifetime low.

Outlook

Event line up in near future shall be instrumental in deciding the fate of the Indian economy, the rupee in particular. The

policy announcement on 17

th

June is unlikely to be bold. A weakened home currency would make it difficult for RBI to cut

interest rates, though a CRR cut can be expected. The headline economic indicators are unlikely to rescue rupee, CPI and

Manufacturing output arrived weaker than expected and Trade deficit scheduled to release last week of June is highly

unlikely to narrow down from previous month’s score of $17.8 billion as import of crude oil, coal, iron scrap, fertilizer and

pesticides is expected to rise in line with the seasonal trends. The only other red flags apart from these are “meltdown” in

international markets and Japanese Central Bank resorting to monetary easing, which could unleash strengthening of

dollar against the yen, the prime carry currency and G4 rival basket, thus leading to rupee depreciation. Bearing this

scenario in mind, we expect rupee to consolidate and range between 57.00 – 59.00 in the near future.

Global Currencies heat map

Source: FT.com

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For any details contact:

Currency Advisory Desk - +91 22 3958 3600

currencyresearch@motilaloswal.com

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