The economy has to work hard to justify currency strength
India’s fundamentals are not as bad as it is made out to be by the currency markets. The case for the Indian Rupee strengthening from its lows is strong and in all likelihood, it will strengthen down the line as markets stabilize. However, this is not the point of this analysis. The point is that India cannot sit on its backside and expect that a large economy, with a young and growing labour force will drive the economy forward. India also cannot look at other countries, especially the debt ridden countries in the Eurozone and say we are better off than you.
Indian businesses have to get off their mind sets that the Rupee is a one way street, where the currency is expected to strengthen at all points of time. This attitude of India is a growth economy and money will pour in is what has driven the country to panic when things turned around.
India has to reconcile to the fact that unless the stakeholders (read politicians, businesses, regulators and the average Indian) work towards a stronger economy, it will not happen. The currency markets are giving a clear warning that India cannot expect money to flow in to the country irrespective of policies.
A star sportsman will struggle if he or she loses the way (Tiger Woods for example), and India seems have to lost its way. The country has to work hard to get back its star status now and if the country actually works harder, it will be because of the panic caused by a falling Rupee.
India went into a panic mode on the 15th of December 2011 when the Indian Rupee (INR) crossed the Rs 54 to the US Dollar (USD) levels. The INR fell to its lowest on record against the USD when it crossed the Rs 54 level and so called experts were screaming for the RBI to do something about the INR fall. Media played to the gallery with various analyses on who will be affected and what are the repercussions of a weak INR. There were even people praying for gods to step in to prevent the INR from falling further! The way the fall in INR was portrayed it looked as if the Indian economy was collapsing.
RBI obliged by first intervening to sell USD to strengthen the INR and then by imposing curbs on forward transaction and open long positions on the currency pair. The INR strengthened on the back of the RBI moves and came off from Rs 54 to Rs 52.50 levels. It is unlikely that the INR will test its lows in the near future given RBI’s curbs and given the fact that the central bank is seen ready to act on further INR weakness.
It is a debatable point of whether Rs 54 is the wrong level for the INR and as with all markets, the INR fall was more momentum led than fundamental led. On the market side the INR weakened on the back of a strong USD strength with the US Dollar index rising by 7.5% since August 2008. On the fundamental side, the widening trade gap, which has gone up by over 30% year on year in the April-November 2011 period has hit INR sentiments. The markets worried about a rising current account gap due to the rise in trade deficit. Current account deficit is expected to cross 3.5% of GDP in 2011-12 against levels of 2.6% of GDP seen in 2010-11.
The worries of maturities of FCCB (Foreign Currency Convertible Bonds) to the extent of Rs 33,000 crores (USD 6.2 billion), which are coming up for repayment in 2012 also played a factor in driving the INR down. On the sentiment side the lack of political consensus on reforms and the government’s inability to give confidence to investors on the path of the economy placed pressure on the INR.
On the capital account front, the headline grabbing FII flows (equity plus debt) were in fact positive to the extent of Rs 16,000 crores or USD 3 billion (January – November 2011), while FDI flows at Rs 111,000 crores or USD 21 billion for April-August 2011 was higher by over 85% on a year on year basis.
India is still a long way off from a Eurozone like crisis, where countries with high debt are facing recession due to forced austerity measures. India’s GDP growth for 2011-12 is forecast at 7% to 7.5% levels. India foreign exchange reserves at over USD 300 billion are over 7 months of imports. The RBI has room to infuse liquidity and reduce interest rates if growth falls below trend as the CRR (Cash Reserve Ratio) is at 6% of net deposits and the benchmark policy rate, the repo rate is at 8.5%.