INR: Future tense?

One recent phenomenon that has been in the limelight apart from rising interest rates and high inflation is the rupee movement. The first 10 months of the present fiscal have seen the rupee swing wildly in both directions, which has taken many experts by surprise. In the first nine month period, the rupee depreciated by as much as 18 per cent. But there is a twist in the tale. With the beginning of 2012, the rupee has commenced a move in the opposite direction and started appreciating. In 2012, on a YTD basis, the rupee has appreciated by 8.75 per cent and currently trades at Rs 49 per USD.

In the month of October 2011, when the rupee began depreciating against the USD, there were many experts who felt that we now have to live with the fact of the rupee being at Rs 53/54 per USD. However, we did not concur with that opinion, as we made clear in our cover story titled  ‘Tumbling Rupee’ published in DSIJ Vol. 26 Issue No. 22 (dated 23rd October 2011). In our story, we had clearly concluded that the rupee would appreciate to Rs 48-49 levels in the next six months, and we have been proved right.

Now, the question is, where is the rupee heading in CY2012 and what will its impact on various sectors be? At the very beginning of CY2012, the tides have changed and the rupee has started appreciating. Going forward, we stick to our conviction and hope to see the rupee hovering around the Rs 48-49 mark per USD for the rest of CY2012. The next important question is how would the rupee impact different sectors and players, especially those who are directly or indirectly involved in exports and imports. Most importantly, we also need to look at the steps that are being taken by the RBI and at the impact these would have on the fiscal situation of the country.

Initiatives By The RBI

At the outset, there had been a lot of buzz about the impact that the depreciating rupee would have on the fiscal condition of the country, which is already reeling under pressure. However, there has been some respite on this front, as the rupee has appreciated by seven per cent since the beginning of January 2012. Here, the actions of the RBI need to be especially mentioned as the timing of these actions prevented the further fall of the rupee.

On December 15, 2011, the RBI took some steps to stem the rupee depreciation. Its move came in after the rupee hit a lifetime low of 54.30 against the USD. Some of the steps taken by the central bank included raising the cost ceiling on ECBs and increasing interest rates on foreign currency deposits, which helped the rupee to appreciate by improving dollar flows into the country. The bank sold US dollars through public sector banks, which led the rupee to appreciate. The RBI also asked banks to square off their open positions, which in turn helped in reducing the overnight positions kept open by the banks on a speculative basis to gain from currency movements. Also, forward contracts booked by FIIs and companies, once cancelled, were not allowed to be re-booked.

Another step that it initiated was that the hedging limit for companies was reduced for exports and imports. The average limit on import and export turnover has been reduced to 25 per cent from the previous 75 per cent over the past three years. Currently, all forward contracts would be on a delivery basis, and not just for trading purposes. However, the contracts can be rolled over once they expire. This move will restrict companies from playing aggressively in the currency market.

This much-awaited move came in at an appropriate time, as investors and market-watchers expected the RBI to intervene in the currency movement. With speculation done away with, the markets would have demand-supply trade, which will be having a healthier effect going forward. Some pressure has also been eased from companies that are net importers, as they have been bearing a high costs for their imports. The cost of import of crude keeps rising as the rupee depreciates, which ends up widening the country’s deficits and also adds to inflationary pressures.

“For CY12, the movement in the INR will likely be driven by three broad factors – the EU sovereign crisis, the global monetary responses to the economic slowdown and the domestic growth prospects. However, the EU sovereign crisis should remain the main driver, especially in H1 2012”, opines Shivom Chakravarti, Economist, HDFC Bank.

Impact On The Economy

There have been several concerns that have arisen due to the depreciating rupee in the previous calendar year. The impact of the rupee movement can be felt in the current account deficit (CAD). A close monitoring of the short-term external debt is required to be done in FY2012-13. However, on the capital account front, recent policy measures have stimulated capital flows in the form of investments by FIIs in debt as well as equity instruments and NRI deposits from the very beginning of 2012.[PAGE BREAK]
Going forward, however, it would be necessary to reduce dependence on debt inflows and accelerate the reforms process in order to ensure revival of equity flows, as investors look for strong growth opportunities in an otherwise gloomy global environment. The widening trade deficit recorded up to December 2011 was largely driven by imports of oil, gold and silver. Import of oil is relatively inelastic to changes in international prices and exchange rates. The rise in imports of petroleum, oil and lubricants (POL) is largely reflective of the increase in international oil prices. While the average international price of Indian oil basket increased by 38.6 per cent during April-December 2011 over April-December 2010, imports of POL (in value terms) expanded by 40.1 per cent during the same period.

The rise in external debt from USD 306.4 billion during the end of March 2011 to USD 326.6 billion during the end of September 2011 is largely attributed to the increase in ECBs, export credits and short-term debt. With increasing recourse to debt creating flows for financing the CAD, India’s external debt is likely to rise further. Increased flows on account of ECBs and NRI deposits may have some implications for India’s external debt in coming quarters. India’s non-debt external capital being large, the strong long-term growth could make external debt rollovers relatively smooth.

“Over the next month, the possible passage of the Greek bailout deal including the PSI program, the relatively subdued domestic inflation pressures and the ECB’s long term refinancing operation (LTRO) could ensure some appreciation in the INR. The ECB’s LTRO program has reduced the tail risk of a European banking sector crisis, which will benefit risk appetite. We expect a possible range of Rs 48.50-50 in Q1 2012”, Chakravarti says.

Impact On Sectors

India Inc. is musing about the past rupee movement and how it is likely to pan out going forward in CY2012. Higher raw material costs, a rise in the wage bill, depreciation and an increase in other expenses have kept the overall margins of India Inc. under pressure in Q3 FY12.

In the last calendar year, the depreciating rupee played spoilsport, which in turn made imported components costlier, thereby squeezing profit margins. The depreciating rupee has pushed up the prices of electronic gadgets and home appliances. Car makers, who import 10-40 percent of the components, are contemplating increasing prices. This is an attempt to offset the increased import costs owing to the depreciating rupee. The hospitality sector could get a fillip, as vacationing in India would become cheaper for foreign tourists. On the contrary, foreign travel and education abroad are likely to become dearer. Export-oriented firms like IT will fare well over the long term. Those investors who want to be safe can concentrate on sectors like pharma and FMCG that focus on domestic demand. Exporters of precious gems and diamonds could see some profits as the rupee depreciates. Textile exporters will have an edge over China and Bangladesh, as their products would be more competitive in the foreign markets now. The depreciation of the rupee since August 2011 itself would have a favourable impact on exports during 2012-13.

However, keeping in view the dominance of inelastic importable items in India’s import basket and the imperfect labour markets, expenditure switching policies may not necessarily bring about the desired adjustment in the current account deficit. Further, to restrain the oil demand, additional deregulation of prices of petroleum products may be expedited. Also, fiscal spending may need to be restrained so that absorption is contained and the twin deficits do not feed on each other.

FCCB Fears

One of the factors that the Indian Inc. has to keep a close watch on going forward is the upcoming Foreign Currency Convertible Bond (FCCB) redemption. During the bull run of 2007, many companies tapped the market and were able to raise hefty sums of money through the FCCB route. The conversion rates of the bonds at that point of time were set at much higher prices as compared to their current prices. Over the last five years, Indian companies issued FCCBs to the tune of USD 20 billion, or around Rs 90000 crore, at an average exchange rate of Rs 45 per USD. Due to subdued sentiments in the Indian equity market, Indian companies may require to plan innovatively to facilitate the conversion of FCCBs into equity. This is to guard against a consequent deterioration in the debt-equity ratio, which may have a balance sheet impact.[PAGE BREAK]
Amidst rising fragilities and uncertainties surrounding the global economic outlook, the rolling over of overseas borrowings of Indian companies may become more expensive. Furthermore, the depreciating rupee may also offset the advantage of the interest rate differential between domestic and overseas borrowings and impact the balance sheet of corporates. It is incumbent upon corporates to suitably hedge their receivables and payables against the exchange rate volatilities.

UPCOMING DELUGE OF FCCB DUES

India Inc. would have never thought that it would need to repay the money raised through the FCCB route, as many company managements thought that the Indian equity market would continue to surge, and thus, bondholders would opt for equity. But after the collapse of Lehman Brothers, life isn’t the same as it used to be. Many of the companies’ stock prices are yet to reach that level, and hence, there is a strong possibility that companies would need to arrange for funds to repay the FCCB money.

We, at the Core Research Unit (CRU) of DSIJ, believe that about Rs 35000 crore of FCCBs would become due for repayment over the next one year, and many companies would find it difficult to fund the same. This can exert tremendous pressure on the Indian companies to borrow money through the ECBs, which could put added pressure on the rupee. Our advice to readers is to play with caution on companies where FCCBs are due in the next six months and the difference between the conversion price and Current Market Price is more than 30 per cent.

The following table would help you to play your cards well:

Conclusion

Any national currency plays a pivotal role in the overall development of the economy. As we have seen earlier, with the depreciation in the rupee, there has been talk of learning to live with the rupee at 53-54 levels against the USD. This has raised eyebrows for the impact that it will have on the fiscal front with the import bill rising further, as also the depletion in the foreign exchange reserves.

With the timely intervention of the RBI, though, the fiasco has been stemmed for the time being. The steps taken by the RBI will start showing results with the passage of time. “Over the longer term, we expect ample G-3 liquidity chasing higher yielding EM assets to emerge as the dominant theme, ensuring that the USD/INR pair is likely to move towards the Rs 47-48 range towards the end of 2012”, concludes Chakravarti.

However, as mentioned earlier, the steps of intervention that have been made by the RBI to help the rupee to appreciate have to be reduced going forward. We still believe that the RBI and the government will work together to stem any similar event in the future as far as rupee depreciation is concerned. We are of the opinion that the rupee is likely to remain between Rs 47-49 for the rest of CY2012.