Since beginning of 2017 the US dollar has depreciated against all major currencies in the world except the Turkish Lira which has been facing political turmoil. The dollar weakened against the Japanese Yen by 7.2 per cent, then South Korean Won by 5.9 per cent and against the Euro by almost one per cent. The same trend was observed against the Indian rupee too where it’s down against the rupee by 5.1 per cent. When Trump came to power the dollar rallied as everyone thought that he will bring in a fiscal stimulus. Somewhere, sentiments have started sinking in that Trump may still be little away from bringing in a fiscal stimulus. Trump in the meantime continues to remain unpredictable despite six months in office as President. He has been changing his stand over various issues – be it on taking hard measures against China for trade, or his new approach with Russia which now no longer has the same vibes as when he contested the presidential election.
The recent much touted Obamacare repeal bill falling through created doubts about whether Trump can really push the fiscal stimulus that he had promised. His latest tweet on China is stark contrast to what he has been maintaining that China is a currency manipulator. He tweeted, “Why would I call China a currency manipulator when they are working with us on the North Korea problem? We will see what happens!”
With all this, the rupee touched a 20 month high recently. It’s trading at 64.55 per dollar, up from last April’s level of 66.47 per dollar. This is despite that we went through demonetisation, Raghuram Rajan quitting as RBI governor who had a great image for maintaining stability of rupee and last but not the least huge ECB redemptions at the fag end of 2016.
There are various fundamental reasons for the rupee to appreciate against the dollar. First India has maintained its twin deficits under control – Fiscal, as well as Current Account, that has helped. Strong FPI inflows have also helped. “The strengthening of the rupee is mainly due to the sudden inflow of FPI into the economy in both the debt and equity segments. The debt limits of FPI in G-Secs was also enhanced which hastened this flow,” informs Madan Sabnavis, chief economist, CARE Ratings. In March 2017, Reserve Bank of India increased the overall FPI limits by Rs 170 billion that consists of Central government securities by Rs 110 billion and state development loans by Rs 60 billion. For FPIs a carry trade in Indian debt market makes more sense as Indian debt papers offer higher yields. In this carry trade FPIs are borrowing from other markets to pump money into Indian debt papers. The stronger rupee against dollar lifts their confidence of not losing on the rupee value much higher. Right now it looks that the carry trade may continue for some more time, as the RBI may not be in a hurry to lower interest rates, as it believes that inflation may well spike in second half of 2017. In first month of 2017 FPI net investment was negative, but year to date, they have pumped in Rs 86,611 crore in the Indian markets (debt plus equity). This is quite a contrast from what we saw in 2016 (calendar year) where FPIs sold, with net outflows off Rs 23,079 crore. As per NSDL website, as on 13 April FPIs had reached the limit of 71.1 per cent in government securities and 75 per cent in corporate bonds. In the past we have seen that FPIs reaching the available full limit. Hence one can expect more FPI inflows in G-sec, as the RBI is expected to raise the limit gain.
Not to forget that FDI inflows continue to be robust for India. The data available on the DIPP website shows that in first nine months of FY17, FDI equity inflows were up by 23 per cent, with a figure of Rs 3.11 lakh crore as against Rs 2.53 lakh crore in same period last year.
The price of crude oil is yet another major factor as this is a dollar guzzling import item for India. In the last few years, India’s crude import bills have come down drastically. The RBI website shows, India’s import bill on crude was $164.7 billion in FY14 but stood at $82.9 billion in FY16. The data for FY17 is not yet out but with oil prices soft, it should be down as compared to last year. The Economic Survey published on 31 January 2017 states that POL imports declined by 7.4 per cent for April to December as compared to same period last year.
Strong FPI inflows, India’s financial prudence, strong FDI inflows and crude oil prices remaining in the range of $40-50 per barrel have all helped the rupee to remain strong. Also Trump’s flipflops took some glitter off the dollar. It appears to outsiders that he may not be in favour of a strong dollar. Today India’s forex reserves are also at very comfortable level at $369 billion, giving enough fire power to RBI to intervene if the need arises. So far the RBI has not intervened much even though the rupee has appreciated significantly against the dollar. “RBI will intervene only in case there is speculative activity causing volatility. Presently we have seen limited intervention which is driven by fundamentals. Intervention also means enhancing liquidity in the system, which is a major issue after demonetisation” explains Sabnavis.
Normally a stronger rupee hurts Indian exports. But we have not seen this trend yet. On the contrary India’s exports are on the mend, especially in the non-IT space as the world economy is on a recovery path. But there is little concern on two fronts. First software receipts and remittances. In the first nine months of the FY17 software receipts declined by $1 billion to $53 billion as against same period last year of $54 billion. Remittances by Indians overseas, another major source of inflows also declined by as much as $5.6 billion to $41.8 billion as against $47.8 billion for the same period last year. “Growth in exports that we experienced over last few months may not sustain, since these are past orders booked at higher dollar rates” informs Sajal Gupta, Head, Forex and Rates at Edelweiss Securities. So it would be critical to watch how exports pan out in next couple of months.
So where do we see the rupee going forward? Can this strength sustain? For the record the Indian rupee has remained quite stable for sustained periods of time (albeit there was some depreciation in between) for the period between 1999 and 2008. In 1999 average dollar rupee rate was Rs 43.04 while in 2008 it was at Rs 43.50. In the interim the rupee did see volatility but not too much to worry about. During that period Indian economy was doing great, especially from 2003 till sub-prime crisis hit and threw all calculations out of the window. Many in India Inc borrowed money through FCCBs and ECBs as a strong rupee with low coupon rate was exciting proposition to drive growth organically as well as inorganically. The sharp rupee decline post the Lehman crisis hurt many companies as not only business suffered due to the global slowdown, but the rupee depreciating against dollar made them pay much more money in dollar terms. What made matters worse was when in 2012 the rupee saw a major decline in a few months, creating a scare among many importers as well as those who had borrowed in foreign currencies. The present strength of the rupee is good news to companies which have borrowed in dollars as they will have to shell out fewer dollars to repay the same. Sectors that are heavily dependent on exports like IT, pharma and textiles (made ups) would also be impacted as their revenue in rupee terms will take a beating as to additionally they are net forex earners.
So where do we see rupee by December 2017?
The forex market is a complex market and many experts have often gone wrong. Many corporate treasuries have burnt their fingers heavily taking bets on which side the rupee vs dollar would move. But, after all the dollar and rupee rate is a function of demand and supply, subject of course to periodic RBI interventions to check extreme volatility. If there is more FDI, FPI flows and exports there is less reason for the rupee to depreciate in the near future. On the other hand, if crude oil prices start moving up it can hurt the rupee badly. Right now on balance, there are more factors that indicate that the rupee can remain strong in the near future as FDI as well as FPI flows and remittances are likely to be strong. Jamal Mecklai, a forex expert in a recent interview suggested that we may have to live with a rupee stronger than most people expected. The global economic outlook is improving helping India’s merchandise exports to grow. And last but not the least this government is committed to fiscal prudence where it is tackling unwanted subsidies and improving revenues to keep India’s deficits under control. Many are calling India an “island of stability for next five years”. The recent IMD prediction that this time the South West monsoon may be normal and well spread, also takes away some worry on inflation. On the other hand, crude oil price movements continue to be a worry factor. Any wild swings on upside can make things worse for Indian rupee. It’s important to note that whatever forex is earned through IT, plus auto and auto ancillary plus and pharma exports goes to meet just one import item – crude oil.
Yet not all are equally bullish on rupee strengthening. “We believe that the rupee will weaken and can go to the level of 66-67/$ by March 2018” predicts Sabnavis. Indranil Sen Gupta of Bank of America Merrill Lynch writes in his report predicting the rupee to be at Rs 70 level by December 2017. “As per Real Effective Exchange Rate (REER), Indian rupee is at an all time high over-valuation, which shall negatively impact exports and trade deficit, although with some lag. I don’t think we can sustain at this level. My sense is that in next 3-4 months rupee may depreciate. Our sense is that it should be in the region of Rs 67-67.5 by December 2017” Informs Gupta.
But Business India is confident that the rupee may not see any major depreciation in the immediate future, if at all it has to move down. In that sense rupee is expected to remain stable. This should help many people to plan their businesses. The rupee taking a huge beating with great volatility that we saw in the past is behind us. We are moving into more stable regime and this is big news on forex front. The Modi government is also not very keen to allow the rupee to depreciate to boost the Make In India concept. Their approach is to make the logistics infrastructure competitive rather than play on the rupee rate to make India an attractive destination.
This change in stand is a welcome move. After all stronger rupee does send this right signals to the world outside. If the Modi government lives up to the promises it made, who knows the rupee may be in structural boom period for many years to come as we have all right ingredients to make this happen.