|Raghuram Rajan, the new head of the Reserve Bank of India|
With India’s government debt at nightmare levels, the currency is likely to remain under pressure despite central bank efforts to slash spot dollar demand, including lending dollars from its reserves to state-run oil companies. Analysts were split over its prospects for the rest of the year before Rajan’s appointment. Bankers are increasingly concerned about the prospects for the Indian economy.
India imports nearly 80% of its oil, but the weakening rupee, together with a 16% oil-price rise, has boosted the bill for IndianOil, Hindustan Petroleum and Bharat Petroleum in the past three months from an estimated $220 million a day to $300 million.
The oil companies have to go to the open FX market to sell rupees to buy dollars to pay for the imports, but the RBI has pledged an FX swap window sufficient to meet the firms’ entire daily dollar requirements.
Oil and gold are the two main contributors to India’s $88 billion current account deficit. The government, which has cracked down on gold imports and raised duty, is now considering selling some of its 558 tonnes of reserves to curb import demand.
The announcement by the RBI triggered the biggest one-day bounce in the rupee in more than 25 years from a record low of 68.83 to the dollar to 66.60.
However, the rebound still left the rupee 16.5% below its level on May 23, the day before the US Federal Reserve first hinted it might scale back its quantitative easing programme.
Fears that the cheap funds bonanza might be coming to an end triggered a sell-off by foreign investors across emerging markets, which has seen currencies from the Turkish lira to the Brazilian real depreciate precipitously.
The run on the rupee, exacerbated by fears that the slowing economy will scare away investors, has made it the worst-performing emerging market currency this year. That prophecy has become self-fulfilling – capital outflows topped $2.2 billion in August as global funds unloaded equities and local-currency bonds.
“The RBI’s intervention to provide dollars to the oil companies has stemmed the fall for the time being, but it’s being looked at as a quick fix,” says Amir Khan, corporate dealer at Currencies Direct.
“The danger is that they have to take an estimated $9 billion a month from foreign reserves of $280 billion, so they can’t go on for very long, and that’s when it’s going to spiral out again.
“With the dramatic fall we’ve seen, 70 to the dollar can’t be ruled out, and given the currency is performing this badly on tapering, it could slide even further once tapering starts.”
He adds: “There’s not much India can do – the only option is to open up the economy and bring in structural reforms but it looks like they’re unwilling to do it.”
As the crisis of confidence deepens, global banks have turned bearish. Bank of America has warned that the rupee could slump to 75 to the dollar by end-2014. UBS and Standard Chartered recently cut their 2013/14 growth forecasts to 4.7% from 5.5%.
Standard Chartered said it was concerned that wholesale price inflation and the fiscal deficit might rise. The bank also cited a slowdown in production, with a knock-on effect to the services sector that it expects to broaden as the year progresses, with little respite in sight in the face of rupee losses, higher rates and poor sentiment.
After a decade of strong growth of around 9% a year, the economy grew just 5% in the year to March. The RBI has cut its 6.5% projection for this year twice in the past six months, but as recently as July 30 was still forecasting growth of 5.7%.
“Markets are increasingly concerned about a negative feedback loop between the rupee and India’s fundamentals,” Standard Chartered analysts say in a recent report, but they stress that worries about a repeat of the 1991 balance-of-payments crisis – when India was forced to airlift its gold reserves to secure an emergency IMF loan – are overblown.
“The rupee’s move upwards from 65 to the dollar to almost 69 was very rapid and did look like it was largely speculative in nature rather than actual dollar demand going through,” says Priyanka Kishore, FX strategist at Standard Chartered. “We will go back below 65, but I’m less certain whether it can move below 65 into a firm position with sentiment stalling and people taking off their long positions trying to cap profits.
“US non-farm payroll data are very important from a Fed perspective and a lot of this move is to do with the US dollar move. If we see NFP confirm that September tapering is happening, we could see the dollar-rupee rate go back up from there, so in the near term there is a down move and some consolidation.”
Kishore says this does not change the overall fundamental story for India, which is slightly negative for the rupee, but stresses the currency is undervalued by 18% on a real basis. She forecasts the rupee strengthening to 64 to the dollar for the fourth quarter, after a weaker third quarter at 68.
Kishore concludes: “Valuations are very attractive and the current account is improving, and that will become more evident as we go into the fourth quarter.
“So there are these economic stabilizers that are kicking in, and once the market knows the extent of Fed tapering, we’re probably going to get a relief rally in Asian currencies.”