The outlook for the INR does appear better than what is was a few months back when the markets turned volatile by the talk of Fed withdrawing stimulus. Global equities and currencies have regained poise since then with US indices trading at record highs and the Euro strengthening against the USD while markets are switching from low yield safe haven US treasuries to higher risk assets. On the domestic front the expectations are that the CAD will come off while inflation expectations are down. The government on its part is not damaging deficits though the food security bill is raising concerns.
INR influencing markets and policy makers
The Indian Rupee (INR) is the focus of both the markets and policy makers. The INR touched all time lows of Rs 61.21 against the USD in the first week of July 2013 and is closing the month at levels of around Rs 60.
The fall in the value of the INR that is down over 10% since April 2013 has had markets and policy makers in a tizzy. The Sensex and Nifty are down by 4% from highs while the ten year benchmark government bond yield is up 100bps from lows seen over the last three months. The government is focused on bringing in capital flows through the FII and FDI route while the RBI has curbed speculation in currency markets and has made liquidity expensive to give strength to the INR.
RBI in its monetary policy review on the 30th of July 2013 has clearly spelt out its policy stance of first achieving INR stability before focusing attention on growth and inflation. The central bank revised forecasts for GDP growth from 5.7% to 5.5% for fiscal 2013-14 while it lowered its March 2014 inflation target from 5.5% to 5%. Economic indicators, from private final consumption expenditure that has grown by 4% in 2012-13 against an 8% growth seen in 2011-12 to the index of industrial production that showed a negative growth of 1.6% in May 2013 against a growth rate of 2.5% seen in May 2012, point to growth slowdown.
RBI is keen to get back on its path to monetary easing but it first wants the INR to stabilize. Hence bond yields will stay high and equities will be volatile until there is stability in the INR.
What are the factors that will lend stability to the INR?
The factors that will lend stability are both global and domestic in nature. On the global front the INR will gain stability if
1. US Federal Reserve (Fed) manages to bring down and end its USD 85 billion a month asset purchase program in a non disruptive and calibrated manner. The Fed has indicated that it will end its asset purchase program by April 2014 and is likely to gradually bring down the size of the program starting September 2013. The gradual withdrawal of liquidity by the fed will reduce volatility in global currency markets. The INR will benefit from this lower volatility.
2. Stability in the Eurozone. European markets have had a relatively stable run over the last one year. The Euro has strengthened by 7% against the USD over the last one year while ten year bond yields of indebted countries of Spain and Italy have come off by 200bps and 160bps respectively. The European Central Bank (ECB) has pledged to maintain accommodative policy for as long as it takes for the Eurozone economies to recover. Stability in the Eurozone is positive for INR stability as risk aversion reduces in the markets.
3.China’s economic growth stabilizing at lower levels. China is seeing a trend growth slowdown with GDP growth forecast at 7.5% levels for 2013 against high double digit growth seen in the most of the 2000-2010 period. China is facing issues of over lending through non banking channels (shadow banking), over investment, property bubbles and slowdown in exports. China’s growth slowdown is leading to soft commodity prices with the Reuters CRB commodity index down 5% over the last one year. China managing to stabilize its economy at lower levels of growth is positive for the INR as Asian economies will not falter by much on falling growth levels in China and commodity prices will not show sharp upward movements.
The domestic factors that will lend stability to the INR are
1. India’s Current Account Deficit (CAD) showing signs of coming off from record levels of 4.8% of GDP seen in 2012-13. The first quarter of fiscal 2013-14 has not been positive for the CAD as trade deficit is up 18% year on year on the back of a sharp rise of 95% in gold imports. The government and the RBI have framed policies to curb gold imports and if that works, trade deficit will come down leading to less pressure on the CAD. The weak INR will help exports to register growth but that is also dependent on the state of the global economy.
2. Inflation keeping its head down. Inflation as measured by the WPI (Wholesale Price Index) has come off from levels of 7.5% to levels of 4.9% over the last one year. Consumer Price Inflation has however stayed sticky at 9.9% levels. The fall in economic growth coupled with weak aggregate demand should keep inflation expectations down. India’s monsoons have been better than normal this year and this bodes well for food prices coming off. The risks to inflation is a surge in global oil prices but that looks unlikely given that the US is achieving self sufficiency in oil thereby reducing its oil imports.
3.The run up to the general elections are not disruptive. India is heading for assembly elections in 2014 and early indications are that the poll results could produce no clear winners. The government should not embrace measures that will widen the fiscal and current account deficit in the run up to the polls.