Rupee over 60: Why currency weakness may be here to stay
Domestic forwards markets, which
reflect market expectations, see the rupee trading at around 65 to the
dollar in a year, while offshore forward markets see it at 66.
Welcome to the swinging 60s. As
rupee hits record lows, some investors see it headed towards the mid-60s
against the dollar, a reflection of weak economic fundamentals and
expectations the
government will struggle to implement meaningful measures to reverse capital outflows.
Domestic forwards markets, which reflect market expectations, see the
rupee trading at around 65 to the dollar in a year, while offshore
forward markets see it at 66.
Pessimism remains even as the government is widely expected to announce
steps soon to encourage more foreign inflows, including potentially
raising debt abroad, after the Reserve Bank of India's steps to drain
cash from the financial system failed to prop up the currency.
"We're very worried about the situation in India," said Walter Rossini,
who manages the 130 million euro Gestielle Obiettivo India Fund in
Milan.
"There's no fast fix to this situation. Probably we will see a
turnaround of the economic cycle in a few quarters but rupee volatility
will stay for longer. I don't see a strong case for it coming back to
the average level of last year," he said.
The rupee hit a record low of 61.80 on Tuesday, marking a 10 percent
fall so far this year - the worst performer in emerging Asia in
currencies tracked by Reuters. Over two years, it is down 26 percent.
A record high current account deficit at 4.8 percent of gross domestic
product has made India particularly vulnerable in an emerging markets
sell-off sparked by anticipation the U.S. Federal Reserve will soon wind
down its ultra-loose monetary policy.
Graphic on rupee, bonds, implied FX yields, click http://link.reuters.com/gaw89t
Plenty of challenges
One of the first tasks confronting former International Monetary Fund
chief economist Raghuram Rajan, who takes over at the helm of the
central bank on September 5, will be whether to continue the RBI's
liquidity tightening steps, which have failed to stem the decline but
have pushed up short-term borrowing costs, adding to pressure on the
already cooling economy.
In the meantime, New Delhi is widely expected to announce measures such
as raising money from Indians abroad, but emergency steps are likely to
prove insufficient unless India tackles fundamental and years-old
problems that deter more robust inflows from corporations and other
long-term investors.
Those problems include heavy dependence on oil and
gold imports, high inflation and political and bureaucratic gridlock that deter capital investment.
The task facing Rajan and Finance Minister P. Chidambaram is complicated
by the ruling coalition's weakness ahead of general elections by next
May, in a global investor environment that no longer favours emerging
markets.
"At the end of the day, it's a political issue that's really been
holding back India to a large extent. Even with the right policies, if
minority parties don't support reforms, it's going to make it very
difficult for them to move forward," said Rajiv Biswas, economist at IHS
Global Insights in Singapore.
In his current role as chief economic adviser, Rajan has suggested
raising money from Indians abroad or easing overseas borrowing norms -
steps that would be likely to boost the rupee and bring down bond
yields, at least in the near-term.
Raising interest rates, one of the traditional tools for defending a
currency, might attract inflows but risk eroding confidence in an
economy growing at a decade low of 5 percent.
Higher interest rates could also choke off inflows into equity markets,
which have been a relative bright spot. Despite foreign exits over the
past two months, Indian stocks are sitting on net inflows of $12.7
billion in 2013.
"The underlying situation is deteriorating. The economy is struggling to
grow, there is a fiscal and current account deficits, and we are going
into an electoral period," said Philip Poole, global head of macro
investment strategy at HSBC Asset Management in London.
"From a fundamental point of view, the currency looks cheap, but the
flows in the short term are a concern. There needs to be some consistent
policy coming from the government and the central bank."