Rupee depreciation exerts costly toll on India's risk profile


Matthew Turner
Published on:

India’s ECR score hits a three-year low as spiking inflation and a plunging rupee exact a heavy economic toll at a time of fragile growth.

India’s ECR score fell by 0.2 points in August to 52.3, cementing concerns about the country’s rising borrowing costs and deteriorating fiscal position. India’ score decline was a result of lower scores in the survey’s economic outlook (-0.1), monetary/currency stability (-0.1) and government non-payments (-0.1) indicators.

The rupee has depreciated by about 10.5% against the US dollar since April, sparking concerns about India’s fiscal and inflationary pressures. India’s annual rate of inflation spiked to 5.8% in July 2013, compared with 4.9% in June and exceeding the ceiling on the Reserve Bank of India’s benchmark rate of 5%.

Meanwhile, the sovereign’s current account deficit stood at 4.9% of GDP during the 2012-13 fiscal year ending in March.India’s public finances now pose one of the biggest threats to the country’s credit profile, according to ECR analysts. With a government finances score of 4.2 points (out of a possible 10), India’s fiscal strength is the lowest among the Bric economies. The sovereign also scores poorly for hard infrastructure (3.8) and corruption (3.0).

John Sharma, economist at National Bank of Australia and a member of ECR’s expert panel, explains that the country’s high current account is having a negative effect on investment and economic growth: “Investment and economic activity in general are softening against a backdrop of deteriorating external fundamentals, including a weakening rupee, driven in part by the high current account deficit.

“This will limit the scope for rate cuts that the Indian economy so badly needs. Besides, the liquidity-tightening measures from the RBI are likely to dampen growth, and raise the proportion of non-performing loans in the Indian banking system, potentially increasing lending aversion among India's banks. A recovery will be more protracted in the current economic environment,”

The Reserve Bank of India revised down its real GDP growth forecast for the 2013-14 financial year to 5.7% from 6% in the previous round. And near-double-digit growth looks set to remain a thing of a past, according to IMF real GDP growth forecasts. Last year, the economy slowed to 4%, the lowest rate in 10 years (see chart below).

India’s economic challenges have ignited debate about the government’s ability to effectively implement market reforms and attract foreign direct investment. The government is courting foreign capital in the hope of boosting the rupee and plugging the current-account gap.

Deloitte’s global outlook for 2013 recognizes that “the government’s hands are tied, and there is not much room for manoeuvring fiscal and monetary policies given the country’s current economic challenges”.

India’s finance minister, Palaniappan Chidambaram, affirmed the government’s commitment to meet its fiscal deficit targets of 4.8% of GDP for the fiscal year. However, the government’s deficit reductions might be undermined after the Reserve Bank of India tightened capital controls, restricting the amount that Indian businesses can invest abroad, exacerbating fears over India’s deteriorating business environment.

An uncertain policy environment is certainly the last thing India needs if it wishes to keep its investment-grade rating.

This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk