The year 2011 was a tumultuous one for the rupee. It fell to lows never seen before, several times over, causing heartburn to both importers and exporters alike. Although the Reserve Bank of India sold dollars directly in the spot market, this was sporadic and that too only in the recent months. However, it did announce several other measures to ensure steady inflow of foreign currency.
The rupee has fallen from levels of 44.46 in January 2011 to 54.29 in December, a decline of 22 per cent against the US dollar. This decline has been ‘unprecedented', said bankers and analysts.
But 2012 could continue to be tough for the rupee and it could trade in the broad range of 50-54, with some analysts predicting that it may touch 58.
Reason for decline
Inflation continued to remain at elevated levels despite the relentless rate hikes by the RBI. Growth slowed down as investments took a back seat due to high interest rates.
The crisis in the Euro zone saw investors flocking to ‘safe haven' currencies such as the US dollar, thereby putting pressure on all other currencies, particularly emerging market currencies.
Growth slows
A report by Standard Chartered Bank said that deteriorating Indian fundamentals have added to the worries about the rupee. The report states that the sharp fall in the rupee was on the back of October industrial production having fallen by 5.1 per cent year-on-year after growing 2 per cent in September.
Below-trend GDP growth in Q2-FY12 (July-Sep 2011) and a poor start to Q3-FY12 — October IIP was similar to the levels seen in early 2009 — confirm India's economic slowdown. With subdued industrial activity and a lagged negative effect on the services sector, GDP growth may fall below 6.5 per cent year-on-year in the coming quarters.
foreign inflows
A slowdown in foreign inflows — portfolio flows and foreign direct investment (FDI) — added to the pressure on the rupee. While net portfolio inflows (into capital markets) have been largely neutral year-to-date, FDI flows appear to have weakened or at least become less reliable, said a report by HSBC.
Besides, proposed reforms such as foreign direct investment in retail did not come through, which again dented India's image in the eyes of global investors.
According to data from SEBI, FII inflows into both equity and debt markets were Rs 39,839.2 crore as on December 23, as against Rs 1,79,674.6 crore in 2010.
RBI's response
To add to it all, the seeming inaction by the Reserve Bank of India may also have contributed to the rupee's weakness, said analysts. Mr Tarun Anand, Managing Director South Asia, Thomsom Reuters, said: “In a sense, markets work on sentiments. If sentiments are positive all factors move in one direction and if the sentiment is weak, the factors move in the other direction.”
According to the HSBC report, “The market's perception of forex policy has played an important part in the recent rupee weakness. The RBI appeared quick to act against rupee weakness in September, but was equally quick to rebuild its forex reserves in October.
“So, this has left the impression that policymakers are willing to accept rupee weakness as a necessary part of the economy's rebalancing, provided the currency's weakness from current levels is measured.”
Simply put, when the rupee started weakening, the RBI did not intervene in the spot rupee market to sell dollars, immediately. This seemed to drive participants to buy more dollars in the anticipation that the dollar would appreciate further.
This can be seen from the fact that the rupee moved between 44 and 45 between January and beginning of September. From then on it was mainly on a downward trajectory to 54 levels.
Impact
Importers were hit by rising import cost. Exporters suffered losses as they had booked their receivables when the rupee was at higher levels. This notional loss was coupled with actual loss stemming from drying up of exporter orders, given the global slowdown.
The depreciation of the rupee also meant that Indian companies that had borrowed overseas through External Commercial Borrowings (ECBs) and Foreign Currency Convertible Bonds (FCCBs) would face pressure on repayment. Though these companies raised funds at lower rates, they would end up repaying higher amounts as the rupee has depreciated against the dollar.
The latest Financial Stability Report by the Reserve Bank of India states: “FCCBs
raised in pre-crisis years at zero or very low coupons will need to be refinanced through domestic sources at the higher interest rates prevailing currently.”
According to Mr Jagannadham Thunuguntla, Strategist and Head of Research, SMC Global Securities, following the rupee depreciation the additional burden on Indian companies repaying ECBs works out to $5.4 billion or Rs 27,000 crore.
“As per the ICAI guidelines, mark-to-market losses on forex need to be provided as a provision on each quarterly basis in the financial statements. Hence, this additional burden of Rs 27,000 crore on ECB forex conversion can result in ‘Disastrous December' quarterly results,” he said in a report.
Since the ECBs were un-hedged, when the rupee started depreciating, corporates started buying more dollars, adding to the pressure on the rupee, said Mr Anand.
Outlook for 2012
Going by what the experts say, next year, too, will be a challenging one for the rupee.
According to the HSBC report, the rupee has room to fall further if global growth expectations continue to decline and US dollar liquidity pressures intensify further.
“In an environment of moderating global growth expectations and broad de-risking, current account deficit currencies like the rupee will struggle,” the report states.
At a recent press conference in Mumbai, Mr David Bloom, global Head of Foreign Exchange Strategy, HSBC Bank, had said that while nothing has changed in India in the last three months, the rupee is depreciating due to the rapid deterioration in Europe. “We are nowhere near extreme valuations for the rupee and we think the currency could move to 58,” he said.
The report by StanChart states that in the near term, the rupee may weaken further on growth concerns and capital outflows.
“Although India is a relatively closed economy, the rupee is a pro-cyclical currency and cyclical challenges are likely to outweigh seasonal positives into Q1-2012. In addition, we expect little near-term relief for the trade deficit, as exports slow and the reduction in the import bill is limited by oil imports and investors' huge appetite for gold.
“As such, we do not expect rupee strength to resume until economic expectations bottom out, spurring portfolio flows back into Indian markets,” the report said.
The rupee will continue to see a period of high volatility, because of the bad news from the Euro zone. However, the domestic currency could appreciate to 50 in two months' time if the RBI maintains its dovish stance, as was seen in the last monetary policy, said Mr Anand. But the broad range would be 50-54, he added.
A report by Credit Suisse states that the rupee would continue to be weak because of three reasons:
India's trade deficit would not narrow since exports are linked to world GDP growth, and the current global slowdown in India's exports.
The already low FII inflows into debt and equities would remain muted. There could be a surge in FII inflows into government securities when the new limits are auctioned, but it would be temporary.
With the bleak outlook on equities, only debt flows can potentially support the rupee. However, the stress on European banks and depletion of risk appetite could keep the dollar access for Indian corporates restricted.