Rupee's drop a warning for other Asian currencies
The pace of the fall in the rupee to record lows against the dollar may herald an acceleration in the broad sell-off in other currencies in the region.
India’s rupee is the worst performing Asian currency in recent months, hitting a record low of Rs53.52 against the dollar on Tuesday. The rupee is down more than 20% since the end of July and stands 4% lower since last Monday.
Simon Derks, chief strategist at FxPro, says it was not meant to be like this.
“India is one of the Bric countries with massive growth potential,” he says. “Some had earmarked India as offering greater risk/reward than China.”
But like other Asian currencies, the rupee has been hit as foreign investors withdraw capital over worries over global growth and the effects of the eurozone debt crisis.
At the same time, India’s domestic economy has deteriorated sharply, with industrial production falling by 5.1% in October, while the government’s fiscal position has also worsened. High oil prices have had an effect too, pushing the country’s trade deficit close to $20 billion in October, its highest level for 17 years.
Paul Mackel, head of Asian FX research at HSBC, says the abrupt weakness of the rupee is a warning sign for other Asian currencies.
“It is often assumed that the rupee is a laggard,” he says. “But over the last few years we have found that sharp weakness in the rupee precedes the sell-off in other Asian currencies.”
“The swift pace of the rupee’s weakness in recent weeks gives a sense of foreboding for Asian currencies altogether.”
Mackel says it is well known that India’s current account deficit is a point of vulnerability for the rupee. However, he says the real importance of the rupee’s link to its current account deficit is how the currency starts to cluster with other EM current account deficit currencies in times of severe market stress.
Rising rupee correlation with EM deficit currencies a warning of broad Asian FX weakness
|Source: Bloomberg, HSBC|
Sharp rises in the positive correlation between the rupee and other EM current account deficit countries coincide with periods of dramatic weakness in global market sentiment. What follows is important for Asian currencies, since shortly after a rise in correlation between the rupee and other EM deficit currencies, the correlations between the rupee and other Asian currencies start to pick-up as well.
“This leads us to believe that sharp rupee weakness can be seen to act as an important warning signal that other Asian currencies could weaken,” says Mackel.