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07
September 2018
 |
USD vs INR (The Total Investment & Insurance Solutions)
The
Indian rupee on Thursday breached the 72 per US dollar mark for the first time.
The depreciation in Indian rupee is largely in consonance with US dollar
strengthening against all currencies. Since the Indian rupee could not have
been immune to such pressure, the current depreciation was long overdue and
trends in Non-deliverable forwards (NDF) market suggest the pain might not be
just over yet, says a research report.
In the
note, State Bank of India (SBI) says, "In the hindsight, the rupee
depreciation of 13% in 2018 and around 7% since June 2018 when the RBI started
hiking rates is largely in consonance with the US dollar strengthening against
all currencies. We analysed the movement of rupee against dollar since global
financial crisis period and it is quite visible from the data that depreciation
was always followed by appreciation of currency. We believe this time will be
no different as currency will start appreciating once the dust settles for the
currency to settle at a lower level."
The
Indian rupee has now depreciated by 7% from June 2018, when the Reserve Bank of
India (RBI) started hiking rates and close to 13% in 2018. "Thus, by any
stretch of imagination, the depreciation in rupee has now outpaced other Asian
currencies like Indonesia. We believe, beyond a certain level of depreciation,
the costs could outweigh benefits. There are many components of such
cost," the report says.
The
lender also shares an interesting anecdote on asymmetric behaviour on the part
of portfolio investors in times of depreciation and appreciation.
Foreign
portfolio investment (FPI) generally responds negatively to domestic currency
depreciation over a period. This is obvious, as typical portfolio investor
brings in foreign currency but invests in domestic currency and, therefore, a
depreciation in domestic currency will only mean that a portfolio investor will
be able to take out a lower amount of foreign currency compared to what was
originally invested. Thus, it will always be the endeavour of the portfolio
investors to prefer a wait and watch policy in the event of a gradual
depreciation of the domestic currency. Hence, portfolio investors have a
typical asymmetric behaviour as they behave contrarily to appreciation and
depreciation of the domestic currency, SBI says.
"Thus,
it is likely that once the rupee settles at a lower level, portfolio investors
now conspicuous by their absence will return in hordes and the rupee will
appreciate. This is what history of Indian foreign exchange market says and
sometimes the period of appreciating rupee following a depreciating rupee could
be even higher! On a lighter note, this could make both camps happy," the
report added.
Talking
down the rupee as was done recently when the markets were volatile might have
been counterproductive and thus the pace of depreciation picked up frantic pace
in the last week or so. In this context, SBI says, the statement by the finance
minister is most welcome and timely one as it has provided an immediate succour
to battered market sentiments. The RBI could also chip in with a message that
could be most comforting under the current circumstances, it added.
According
to SBI, the largest lender in the country, there are two perceived benefits of
rupee depreciation in the form of increased exports and automatic adjustment of
trade deficit in policy circles. However, it says, it believes the traditional
view that weak exchange rates could dramatically boost exports growth is not
entirely correct over the long term as India’s export basket has changed
significantly from traditional products to more mechanized engineering goods
over the years, thus making them more income elastic rather than price
elastic.
Policymakers
need to be mindful of the several costs of rupee depreciation, like short-term
debt obligation, oil import bill, yields, effect on inflation and return of
portfolio investors, the report says.
It
says, "First, India’s short term debt obligations at $218 billion due on
December 2018 if rolled over could add a significant cost on the Government.
Second, oil import bill could go up manifold. Third, with yields increasing,
this could add up government fiscal costs too. On all these counts the costs
could add up to 0.7% of gross domestic product (GDP). It may be noted that the
yields are already under pressure as unlike earlier years, the government
borrowing programme has been evenly distributed between two halves in current
fiscal."
"Fourth,
as per RBI estimates, assuming a 10% depreciation, this could add upto 50 bps
on inflation number. In fact, continued rupee depreciation could result in rate
action by RBI in October policy, even as headline CPI will decline meaningfully
to 3.6-3.7% in September. This could be thus the biggest predicament waiting to
unravel," SBI says.
India’s
short-term debt obligations as on December 2017 were about $217.6 billion.
Assuming half of the amount either has been paid in first half of 2018 or is
rolled over to 2019, the remaining repayment amount in rupee terms would be
Rs7.1 lakh crore at average 2017 exchange rate of Rs65.1 per US dollar. For
second half, assuming that rupee depreciates to an average value of 71.4
per US dollar, the debt repayment amount would be Rs7.8 lakh crore, thereby
implying an extra cost of Rs67,000 crore.
Talking
about oil import bill, SBI says, it assumes that the volume of India's crude
oil imports would increase by a modest 3.6% (average of past five years) in
2018.
"If
we reduce the volume of oil imported in the first half of the current FY, the
remaining volume of crude to be imported comes to 760 million barrels (bbl). At
an average oil price of $74.24 per bbl for the remaining half, crude import
bill of India in 2018 should amount to $57 billion. If the average exchange
rate remained at Rs65.1 per US dollar, the crude oil import bill would have
been Rs3.64 lakh crore. However, with rupee depreciating to an average of
Rs71.4 per US dollar in second half of 2018 end, the import bill would increase
to Rs4.03 lakh crore, implying an extra cost of around Rs35,300 crore. With
crude oil averaging to $76 per bbl for the remaining half and average exchange
rate at Rs73 per US dollar, the extra cost could go up to Rs45,700 crore
," the report says.
According to RBI of the Indian rupee by
around 5% relative to the baseline, inflation could edge higher by around 20
basis points (bps). With rupee expected to depreciate by say around 14% this
year, SBI feels that keeping everything else constant inflation could edge by
56 bps going by the RBI numbers.
According
to SBI, if the rupee continues to depreciate, it may move RBI towards
increasing the regulatory interest rates and it could pressurise RBI to go for
more rate hikes. RBI’s successive rate hikes will have a negative impact on
private final consumption expenditure (PFCE) as well as investment expenditure,
thereby widening the output gap. For instance, during FY13-14, three successive
rate hikes led to collapse of private consumption expenditure to 2.0% in Q3
FY14-15 from 8.6% growth in Q2 FY14-15. During Q1 FY18-19, PFCE increased by
8.6% (6-quarter high) and RBI has already hiked repo rate in two successive
rate hikes. The continued rupee depreciation and given the significant costs of
RBI intervention in forex market and hence the RBI apathy to take that route
could result in at least one more hike, possibly frontloaded, the report added.The Total Investment & Insurance
Solutions
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