Friday, June 14, 2013

Is INR’s volatility sustainable?

Last couple of weeks would be marked in the history of INR’s (rupee) unpredictability with respect to the American Dollar ($) as the most volatile phase. In the emerging markets INR was the second worst performing currency w.r.t. American Dollar only after Chinese Yuan.

Going through various reports and analysts’ views it has already been established that a country with approximately as wide as 6% of GDP of the Current Account Deficit (CAD) this currency depreciation would add insult to the already injured economy which is battering with slowing demand for goods and services across globe and reeling with high inflationary effect (CPI) in the domestic economy. Keeping all the factors in mind and considering that the country is facing with the twin deficit problem for quite a long time now (not significantly new problem for past 24 months) what has led to this Indian Rupee depreciation suddenly? Why in the last couple of weeks debt portfolios have been the net sellers and the equity portfolios have been stable with persistent inflows to finance our CAD?

Uncle Sam’s recovery (though slow but steady) has boosted the American Dollar’s appreciation:
  • ·         Fed’s Bernanke has indicated the drying up of the asset purchase which stands today at around $85b/month, involving assets like Govt. securities and Mortgage Backed Securities.
  • ·         Sentimental boost for the people across globe that the American economy is back on track with more number of people getting employment but still the unemployment percentage ranges from 7.5% - 7.8%, well below the target set by Fed before the dry up of asset purchase at 6.5%.
  • ·         And slow yet steady GDP growth coupled with Chinese shaky growth momentum and the Industrial production data clarifies the tectonic impulse.

The only factor why the capital inflows in the emerging markets for last few years had been steady was the low interest provided on the money invested in the developed countries but with the mentioned points above it is believed that the sole advantage of interest rate spread would narrow and the American Securities in the coming period would provide better yields on the investments, leading to drying up of the capital inflows in the EM like India.

This adds up to the worry of financing our huge deficit. RBI Governor has iterated number of times that relying on debt to finance our CAD is not a great idea and it has been proved with the new breeds of foreign traders in the debt market that the volatility on the debt investors is questionable and can affect the domestic currency severely. (FII proprietary debt investors)

Leading to the fact that what India needs at this point in time is a reliable source of financing its CAD which can act as a support for the domestic currency and economy’s revival. This can solely be possible if the foreign investors feel comfortable/safe by investing their money in India for a long period of time through Foreign Direct Investments or through controlling more stakes in the sectors which needs capital like in defense and insurance. This can only be possible if the Govt. is committed to improve the economy’s condition by taking actions on reforms but this seems like an elusive dream now with less than a year left for national elections. 

So its all about external factors coupled with domestic reform paralysis which will guide the rupee in the coming months, so better get used to drastic movements of the domestic currency and take appropriate hedges. 

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