The Brighter Side Of The Falling Rupee

The mood in the Indian equity market is grim. The erstwhile poster boy of the global investment fraternity is fast losing its coveted position. The year that started on such a good note, wherein everyone was upbeat about the Indian economy and the equity market (See table: GDP Forecast By Key Players), has suddenly found itself on slippery ground.

Although the Sensex and Nifty are down by only five per cent from the beginning of 2013, many of their constituents like DLF, IDFC, BHEL and JP Associates are trading at their respective 52-week lows. Moreover, the broader market indices like BSE Mid-Cap and Small-Cap are down by 26 per cent and 30 per cent respectively from the start of the year. Technically too, the picture is not looking good, and more than 80 per cent of the stocks are trading lower than their 200-day moving averages.

Although there are many reasons why India’s economic sheen over the last few years is dimming now and impacting the stock market, one factor that clearly stands out is the sharp and steep fall in the external value of the Indian Rupee (INR). Despite all the efforts taken by policymakers at the central bank as well as in the government, it has not helped in arresting the fall of rupee. The currency has depreciated by more than 20 per cent year till date, with most of the fall having occurred in the last three months.

This was inevitable looking at the myopic outlook with which policies were framed and followed in the last few years. When the going was easy and the central banks globally were printing money, it was easy to finance the ever widening Current Account Deficit (CAD). Nonetheless, it was well known that the good times would not continue forever and would reverse some day. Therefore, it would have been prudent for policymakers to take appropriate steps and mend the government’s finances in time. However, they faltered and we are witnessing the repercussions now. The moment the US Federal Reserve uttered the fearful ‘T’ word, all hell broke loose and the ferocity of the rupee depreciation was accentuated.

H G Desai, Director, A V Rajwade and Company, elucidated this point saying, “One of the reasons for this is the policy error of 2009 and 2011, when the INR, after depreciating to the levels of Rs 52, appreciated on the back of better capital inflows. They allowed the rupee to go all the way down to Rs 42-43, which is clearly an overvalued territory, to keep inflation under control as they wanted the inflation rate to determine the currency rate and not the other way round. By keeping the INR overvalued, the CAD expanded”. This clearly exposed our structural problem, which was compounded by the cyclical factors.
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G Chokkalingam, MD & CIO, Centrum Wealth Management explained the structural problems for such a fall. “In the last 10 years, the import of commodities like gold, crude oil, edible oil/oil seeds, coal and fertilisers had gone up anywhere between six and 21 fold, and on the other hand, our exports haven’t kept up proportionate momentum. The second was the failure to understand the serious repercussion of soaring gold imports and address the issue on time”. He further said that, “Had we contained our gold imports in the last 30 months to roughly around USD 60 billion, this crisis of the rupee crash further accelerated by speculators would not have happened”.

This depreciation in the value of the rupee will adversely impact the fiscal balance of the government, as it will lead to a significant jump in the subsidy bill. It is estimated that the subsidy bill is likely to triple from Rs 60000 crore estimated in the Union Budget to Rs 1.8 lakh crore. This will also spur an increase in inflation. Nonetheless, in the long term, we expect the exports to go up and the non-essential imports to come down, and that will help in narrowing down the CAD.

For corporates, the impact will not be uniform and will depend upon which side of the fence they are on. Companies that are sitting on a significant amount of forex loans in their books will suffer the most, and their lenders will also be impacted. Here, Chokkalingam says, “For the corporates which have taken a significant amount of external loans, either the losses would mount or the balance sheet size would shrink (if losses are adjusted against the reserves). Several mid-sized companies would become sick, and hence, the loan losses for banks would also mount”.

Nevertheless, there are certain sectors that will get positively impacted by the rupee’s fall. You can read more about this ahead in this story.

Have we seen the worst of the rupee fall, or is there some more pain left? Speaking to various market participants (See snapshot) gave us the sense that most of the troubles are now behind us. Nevertheless, there are two factors that will remain overhang for a while now. The first is the geopolitical situation unfolding in the Middle East. If this deteriorates further and more countries jump into the fray, it will have serious implication on India too as the prices of crude oil are likely to shoot up.

The second is the quantum and timing of tapering by the Federal Reserve. Looking at the latest data on the US economy, we anticipate that we may see the Fed hitting the ‘T’ button sooner. Although a part of this is already discounted in the market, one cannot rule out the possibility of a kneejerk reaction.

Till the dust settle down around these variables, brace for volatility in the rupee and play safe.
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The Need Of The Hour

Anil Bhansali, Vice President, Mecklai Financials

• Rate cut should be the first and the foremost step that has to be taken to bring the rates to normal, and in fact, lower levels.
• Exporters to be given incentives and the policy should encourage indigenous production of all essential items.
• All capital controls implemented should be removed and a free trade environment should be created.
• Imports of all non-essential items should have highest possible import duties to restrain such imports.
• Gold lying in the lockers of Indians should be brought out by ushering in attractive schemes and should be used for investment.

D K Joshi, Chief Economist, CRISIL

• Focus more on exports with a medium-term focus.
• Work on creating a conducive environment for manufacturing.

H G Desai, Director, A V Rajwade & Co.

• A cut in interest rates is the need of the hour.
• As for the longer-term strategy, the central bank needs to focus on exchange rates.

G Chokkalingam, MD & CIO, Centrum Wealth Management

• Provide speedy approval to over 100 coal mines that are awaiting environmental clearances; implement a commercially viable gas price policy to maximise gas output within the country.
• Have proper crop planning so that on one hand surplus grains don’t rot, and on the other, we end up importing over USD 15 billion worth of edible oil and oilseeds.
• Continue to strictly control imports of gold. Towards this end, encourage sale of domestic gold held by Indian households to the extent of over USD 1.4 trillion – this will help not only in curtailing the import bill, but also in improving the household financial savings.
• Go East as well as West. Opt for currency swaps and barter exchanges with historically friendly nations like Japan and Iran on both sides of our country.

Dr H K Bhanwala, ED & MD Additional Charge, IIFCL

• We have cheap labour as per international standards and have a good saving and investment rate, but we need to push manufacturing and build infrastructure.

Sectors That Stand To Gain

When it comes to investing in the markets, there is always more than one side to consider. If in a particular scenario a particular factor or event makes a negative impact on one part, there are other parts which may be positively influenced. Investment is all about looking for those opportunities to maximise the returns in any given circumstances.
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Similar is the situation for the Indian markets at the current levels. There is great hue and cry on the street about the depreciating rupee and its possible negative impact on the various sectors. In DSIJ Vol. 28, Issue No. 17 (dated August 11, 2013), we had analysed the impact of rupee depreciation on a few sectors. We had categorically stated that Automobile as well as Oil & Gas stocks would be negatively impacted as these companies have been direct importers. In addition to the direct impact on these two sectors, we had also mentioned some sectors that would be indirectly affected. A few of these are Telecom and Capital Goods (on account of higher foreign currency debt) and Power (due to coal imports getting costlier).

But as we stated earlier, any situation in the market is multi-faceted, there are many opportunities in other sectors as a direct outcome of the currency drop.

Pharmaceuticals

The foremost beneficiary of the rupee fall has been the Pharmaceuticals sector. In the past few years, this sector has been generating higher sales due to the generics boom in the developed markets. One of the key factors behind the growth in exports was the depreciating rupee. A combination of these two factors clearly paved the growth path for pharmaceutical companies.

The top 10 Indian pharma companies generated more than 70 per cent of revenues from the export markets. This is a seriously a big chunk. Now, with the rupee breaching the 68 mark against the USD, we feel that the competitiveness of Indian pharma companies would surely increase. We also need to consider the hedging positions of these companies. Considering the hedge positions, we expect a positive impact on companies like Dr Reddy’s Labs, Lupin, Divi’s Laboratories and Strides Arcolab.

IT

IT is the second most important sector that has a size of as large as USD 95 billion, with around 80 per cent revenues being generated from exports (USD 75.80 billion). More specifically, it accounted for 25 per cent of India’s total exports. The impact of the depreciating rupee can be easily ascertained from the fact that in Q1FY14, the revenues of TCS witnessed a sequential growth of 4.10 per cent in dollar terms. In rupee terms, however, growth stood at 9.50 per cent. Now, this may present a confusing picture. But even if we consider the constant currency growth, it was a good 4.80 per cent. This stands true for every export-dependent IT company.

Apart from the depreciating rupee, another positive factor for IT companies is improvement on the macro front in the US and Euro zone economies. While the US account for 56 per cent of revenues (for the top four Indian IT companies), the Euro zone accounts for 27 per cent). So, there is a double booster for companies in this sector.

Textiles/Leather

The Textiles sector is expected to be a beneficiary of the combination of two factors as mentioned above. The textiles sector has remained quite dull as the European as well US economies (major export destinations for Indian textile players) were not growing. With growth expected to come back on track in the developed economies, we expect a positive impact on this sector. Another noticeable factor is that India’s competitiveness has increased as compared to other textile exporters like China, Bangladesh and even Pakistan.

We are of the opinion that the textile companies would also be getting benefited on the operational front as capacity utilisation improves. In the past few years, capacity utilisation has declined significantly, resulting in lower operating margins for these companies.

Similarly, in line with textile sector, even leather exporters are likely to get benefited. However, this space has very few listed entities to could be recommended to the larger investor strata.

Travel & Tourism

Travel and tourism is another sector which is affected by rupee movement. Here, we need to consider both outbound travellers as well as foreign arrivals in India. A depreciating rupee makes travelling outside India costly, and thus, there is a possibility of decline in the number of outbound travels. With budgeted amounts typically set aside for the same, any addition to the cost would impact travellers’ plans.

However, Anil Khandelwal, CFO, Cox & Kings differs with this opinion saying, “Indians work with a budget in mind when they plan their holidays and a fluctuation in exchange rate is not a factor that can act as a deterrent for holidays”. He further adds, “India has experienced a similar cycle of uncertainty even in 2008, when the world was engulfed in a crisis. However, this did not dampen their spirits and Indians continued to travel overseas. For Indians, travelling overseas is an aspiration and they will not give it up just because of rupee depreciation”.

On the inbound front, the depreciating rupee bodes well for the industry as India becomes a cheaper destination to fly into. Many travel agents have confirmed a higher number of enquiries as well as bookings. So, we expect a positive impact on the travel and tourism segment.
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While these are the sectors to be followed, there are also certain individual companies from the beaten down sectors. For example, Bajaj Auto earns 32 per cent of revenues from the export markets. Even Balkrishna Industries earns 90 per cent of revenues from exports. Based on this, we had recommended Bajaj Auto, Balkrishna Industries and Cairn India to investors.

In addition to the short-term factors, there are some in the long term too. First and the foremost, the depreciating rupee provides a competitive edge over the peer exporting countries. This is the time for Indian exporters to grab the opportunity as the rupee has been one of the worst affected currencies, providing additional competitiveness. For example, the likes of Bharat Forge are likely to be benefited.

DSIJ Recommends

Mindtree | BSE Code: 532819 | CMP: Rs 1044 | FV: Rs 10 

Mindtree, a global information technology solutions company, derives 58 per cent of its revenues from the US and 27 per cent from Europe. The remaining is derived from India and the rest of the world.

There are several factors working in the company’s favour. For starters, the US economy is picking up quickly, resulting in higher revenues from the geography. Mindtree’s order book has been robust, and this momentum is expected to continue. Moreover, the depreciation in the rupee will lead to higher realisations and will thus boost topline growth.

On the margins front, the company is expecting headwinds as 80 per cent of the staff’s salary increased with effect from July 1, 2013. However, this will be offset by depreciation in the rupee, improvement in utilisation and an absence of visa costs. This may even lead to an improvement in its margins for Q2FY13.

Cox & Kings | BSE Code: 533144 | CMP: Rs 93 | FV: Rs 5 

The business of Cox & Kings can be bifurcated into segments such as leisure travel (90 per cent of revenues), corporate travel, forex and visa processing. The company is likely to witness strong growth in the leisure business segment, as we are heading towards the holiday season. While inbound travellers are expected to witness strong growth, the company is not expecting any impact of rupee depreciation on the outbound travellers. Apart from strong growth in leisure travel, the other segments are also expected to witness momentum.

After scaling up operations through the major acquisition of HBR, the company is now aiming to trim down its debt. We expect the company to generate good cash flows in the coming quarters, which would help the company reduce its debt levels.

Considering the growth prospects of the company, the estimated EPS for FY14 is expected at Rs 22. Hence, we recommend a ‘buy’ on the scrip with a target price of Rs 120 in the next three quarters.

IPCA Laboratories | BSE Code: 524494 | CMP: Rs 700 | FV: Rs 2 

IPCA Laboratories is set to get the benefit of the rupee depreciation as the company derives more than 61 per cent of its total revenues from the export market. Also note that IPCA Labs emerges as a net forex earning company due to its lower forex outflow. In FY13, the company had total forex revenues of Rs 1716 crore against a total forex expenditure of Rs 158 crore. The exports increased by 20 per cent to Rs 1194 crore during the fiscal, which is a robust performance. The company recently has received US FDA approval for its Indore formulations facility, and hence, exports are expected to see a further rise. One can enter this counter with a one-year price target of Rs 770.