Can the rupee slide be stopped?

By:
Published on:

India’s economy and currency has taken a battering, yet the worst of rupee depreciation should now be behind us. Stability should return, though a more meaningful appreciation of the rupee is still some distance away, writes Sanjay Mathur, Managing Director and Head of Economics Research, Asia Pacific ex-Japan at RBS.

Sanjay Mathur, RBS Chief economist, non-Japan Asia
Sanjay Mathur, Managing Director & Head of Economics Research, Asia Pacific ex-Japan
The Indian currency has been the worst performer in Asia so far this year – plummeting to record lows against the US dollar – the stock market fell 10 per cent in a month and bond yields have surged as investors took fright. The slide in India’s markets are part of a wider exodus of foreign capital from emerging markets prompted by news that the US Federal Reserve is considering scaling back its bond-buying stimulus. That has raised concerns about India’s ability to finance its current account deficit and prompted Prime Minister Manmohan Singh to insist the country had adequate currency reserves and was not heading for a crisis. The irony is that the Indian government has been implementing a raft of measures to address this very issue. Three important developments in June and July point to a more stable future for the rupee. First, efforts to slim the trade deficit by slowing precious metal imports have shown early results. India’s trade deficit narrowed to USD12.3 billion in July versus an average USD17 billion in the previous six months, after the Reserve Bank of India (RBI) introduced measures to restrict gold imports. Import financing for gold and gold imports by trading houses (above that needed by jewellery exporters) are restricted. These measures follow a ban on margin financing for gold imports and the further raising of import tariffs, which are likely to be felt from September. Second, the RBI has tightened domestic liquidity. To curb the supply of rupees and shore up the currency’s value, it raised the marginal standing facility and upped bank rates, capped cash injections into the banking system and increased the banks’ daily minimum cash balance requirements. At the same time, it has managed to discourage speculators by raising the carry-adjusted return over the US dollar. This tightening of liquidity appears in-line with previous IMF prescriptions for countries facing an external crisis. Third, India has introduced a host of measures to encourage foreign direct investment (FDI) — a key policy of the government since coming to power in 2004. Regulations on external commercial borrowing have been liberalised and local subsidiaries of multinational corporations can now borrow freely from their parent companies. Stateowned oil companies will also have access to external borrowing, while state-owned infrastructure finance companies are being encouraged to borrow overseas. Such inflows are likely to increase thanks to the complete deregulation of the rate charged on deposits made by non-resident Indians, making them more attractive by shifting the exchange rate risk from depositor to the bank in which the money is deposited. While inward foreign investment in India is encouraged, outflows are being discouraged. The government must now approve overseas FDI by Indian corporates and at the personal level, remittances flowing out of India have been capped. Indian residents will also no longer be allowed to buy overseas properties. The government hopes all these measures will restrict the rise in capital flows to USD11 billion, or 0.6 per cent of GDP, bringing down the current account deficit and stabilising the rupee. India may still struggle to hit a current account deficit target of 3.7 per cent of GDP this financial year as monetary tightening coincides with already weak growth. However, there is a better demand-supply balance in the rupee that should help the currency stabilise in the immediate term. The trade deficit is narrowing, liquidity conditions have been tightened and the problem of gold imports is being dealt with on a dynamic basis. The most important change is in the policy mindset – rupee stability has taken precedence over all other objectives.
Disclaimer
A version of this article appeared in Bloomberg Brief, Economics Asia on August 29, 2013 This communication has been prepared by The Royal Bank of Scotland N.V., The Royal Bank of Scotland plc or an affiliated entity (‘RBS’). This material should be regarded as a marketing communication and has not been prepared in accordance with the legal and regulatory requirements to promote the independence of research and may have been produced in conjunction with the RBS trading desks that trade as principal in the instruments mentioned herein. This commentary is therefore not independent from the proprietary interests of RBS, which may conflict with your interests. Opinions expressed may differ from the opinions expressed by other divisions of RBS including our investment research department. This material includes references to securities and related derivatives that the firm’s trading desk may make a market in, and in which it is likely as principal to have a long or short position at any time, including possibly a position that was accumulated on the basis of this analysis material prior to its dissem nation. Trading desks may also have or take positions inconsistent with this material. This material may have been made available to other clients of RBS before it has been made available to you and regulatory restrictions on RBS dealing in any financial instruments mentioned at any time before is distributed to you do not apply. This document has been prepared for information purposes only. This document has been prepared on the basis of publicly available information believed to be reliable but no representation, warranty or assurance of any kind, express or implied, is made as to the accuracy or completeness of the information contained herein and RBS and each of their respective affiliates disclaim all liability for any use you or any other party may make of the contents of this document. This document is current as of the indicated date and the contents of this document are subject to change without notice. RBS does not accept any obligation to any recipient to update or correct any such information. Views expressed herein are not intended to be and should not be viewed as advice or as a recommendation. RBS makes no representation and gives no advice in respect of any tax, legal or accounting matters in any applicable jurisdiction. You should make your own independent evaluation of the relevance and adequacy of the information contained in this document and make such other investigations as you deem necessary, including obtaining independent financial advice, before participating in any transaction in respect of the securities referred to in this document. This document is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. The information contained herein is proprietary to RBS and is being provided to selected recipients and may not be given (in whole or in part) or otherwise distributed to any other third party without the prior written consent of RBS. RBS and its respective affiliates connected companies, employees or clients may have an interest in financial instruments of the type described in this document and/or in related financial instruments. Such interest may include dealing in, trading, holding or acting as market-makers in such instruments and may include providing banking, credit and other financial services to any company or issuer of securities or financial instruments referred to herein. This marketing communication is intended for distribution only to major institutional investors as defined in Rule 15a-6(a)(2) of the U.S. Securities Act 1934 (excluding documents produced by our affiliates within the U.S.). Any U.S. recipient wanting further information or to effect any transaction related to this trade idea must contact RBS Securities Inc., 600 Washington Boulevard, Stamford, CT, USA. Telephone: +1 203 897 2700. In Singapore, this marketing communication is intended for distribution only to institutional investors (as defined in Section 4A(1) of the Securities and Futures Act (Cap. 289) of Singapore). In Hong Kong, this marketing communication is intended for distribution only to Professional Investors (as defined in Schedule 1 of the Securities and Futures Ordinance of Hong Kong). Issuers mentioned in any material may be investment banking clients of RBS Securities Inc. and RBS Securities Inc. may have provided in the past, and may provide in the future, financing, advice, and securitization and underwriting services to these clients in connection with which it has received or will receive compensation. Accordingly, information included in or excluded from this material is not independent from the proprietary interests of RBS Securities, Inc., which may conflict with your interests. For further information relating to materials provided by RBS, please view our RBSMarketplace Terms and Conditions: RBSM Terms and Conditions The Royal Bank of Scotland plc. Registered in Scotland No. 90312. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB. The Royal Bank of Scotland plc is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The Royal Bank of Scotland N.V., established in Amsterdam, The Netherlands. Registered with the Chamber of Commerce in The Netherlands, No. 33002587. Authorised by De Nederlandsche Bank N.V. and regulated by the Authority for the Financial Markets in The Netherlands. The Royal Bank of Scotland plc is in certain jurisdictions an authorised agent of The Royal Bank of Scotland N.V. and The Royal Bank of Scotland N.V. is in certain jurisdictions an authorised agent of The Royal Bank of Scotland plc. Copyright © 2013 The Royal Bank of Scotland plc. All rights reserved. This communication is for the use of intended recipients only and the contents may not be reproduced, redistributed, or copied in whole or in part for any purpose without The Royal Bank of Scotland plc’s prior express consent.

Copyright © 2013 RBS Securities Inc. All rights reserved. RBS Securities Inc. member FINRA (http://www.finra.org) / SIPC (http://www.sipc.org), is a subsidiary of The Royal Bank of Scotland plc. RBS is the marketing name for the securities business of RBS Securities Inc.