The Indian Rupee (INR) fall is exclusively due to domestic factors. RBI actions of tightening liquidity has taken up bond yields sharply higher with yields at the short end of the government bond yield curve rising by 400bps while long end yields are up by over 150bps. The rise in bond yields have led to fears of prolonged economic weakness and have led to worries on banks balance sheets. The rise in bond yields has also led to fears of banks showing losses on their government bond holdings. The Bank Nifty has fallen by 22% since 15th July 2013.
On an absolute basis, interest rates in the economy are at levels where it can kill the economy. Money market securities yields are at over 11% levels while five and ten year government bond yields are at levels of 9.5% to 9.25% respectively. Borrowing cost for government and corporate sector rising at a period when the economic growth is running at decade lows is almost fatal to economic growth prospects.
The only hope for the INR is interest rates coming off in the economy. The question is how will interest rates come off? RBI can reverse its tightening policy but markets will be too worried on any reversal of steps to bring down bond yields. Banks will hold back any cut in lending rates as their nerves are shattered by the RBI’s moves. Markets have absolutely no faith in the government taking right decisions even if the government is actually trying to do the right things for the economy.
The market sentiments are frail at this point of time and any signs of optimism will be regarded as foolhardy. However it is the right time to be optimistic as levels of the INR and bond yields reflect fear rather than fundamentals. Fear will take a while to die down but taking the right decisions in times of fear is what makes one successful.
The INR closed at all time lows of Rs 63.13 against the US Dollar on the 19th of August 2013. The INR has fallen by over 5% since RBI unleashed steps to curb INR volatility on the 15th of July. In the period 15th July to date the Sensex and Nifty have fallen by 8.6% and 10% respectively and the ten year bond yield has gone up by 165bps.
The INR fall is definitely not a result of global market volatility as the Euro has strengthened against the USD by 2% while the US Dollar index that tracks the movement of the USD against a basket of major currencies is down 2%.
Emerging market currencies have seen mixed volatility with the Indonesian Rupiah that is down 4.6% to the USD 15th July to date. Malaysian Ringgit is down 2.8% while currencies such as Thai Bhat, Korean Won and Philippine Peso are down by less than 1%. Brazilian Real that is down by 8.6% is the only currency that has depreciated more than the INR. Brazil, Indonesia and India have problems that are largely domestic in nature leading to the severe underperformance.
The INR fall is not a result of worries over the US Federal Reserve (Fed) tapering off bond purchases starting September. US equities are marginally down since 15th July though US treasury yields have moved up by around 30bps. US treasury yields are factoring in an uptick in the US economy and have risen by 140bps from lows over the last couple of years.
FII’s are blamed from the INR fall but their pace of selling is hardly anything to write home about with sales of USD 1.6 billion in debt and sales of around USD 1 billion in equities, 15th July till date. FIIs had sold over USD 6 billion in debt from 1st May to 15th July 2013 and had bought USD 2.3 billion of equities in the same period.