Unifi Corporate Profile

Wednesday, December 7, 2011

Rupee’s stumble on the Dollar

Contributed by Sathyamurthy, Research Analyst at Unifi Capital

Over the last few months, Indian rupee witnessed the largest fall in value against the US dollar, at a speed that created fear among investors at large.  The fear was not irrational in a country that is claimed to be largely insulated from the troubles of the developed world and a potential economic superpower.

High inflation in the country and the large current account deficit, financed primarily by capital inflows has been the key problem. The trauma in global markets due to risk aversion has caused capital flows to dry up.  Companies are struggling to find dollars from euro-zone banks, which supply about half of India’s foreign loans, cutting off credit lines.

India’s growth plan has been to maintain a low current account deficit, financed through capital flows from foreign direct investment and portfolio investments. Neither of these has worked favorably so far. The country’s current account deficit is likely to be higher than 3% of GDP.  Exports declined faster than imports and are likely to continue considering the nature of imports (commodities and oil).  Investment climate has weakened due to the persistently high inflation, high interest rates and slower GDP growth.

The falling rupee has essentially reflected India’s economic weakness. The floundering reforms to increase capital inflow are adding fuel to fire. However, one might argue that the cheaper rupee will boost exports and limit imports.  During the recent result season, large number of companies booked losses due to foreign exchange differences on their foreign currency loans. This raises concerns about these companies refinancing their borrowings now.

In order to opine on the INR’s ability to regain its lost value one would want to look at the possibility of three options that India has. One-to enable more high quality capital inflows into the country by easing rules for foreign lending, (steps in this direction have already begun), two- intervene in the currency markets, buy rupee and sell dollars. This will decrease money supply from the system and borrowing costs will increase. Given the already high interest rates which is visibly hampering growth (7.6% to 6.9%), might not be an option that RBI will pursue. Three, politicians should decide to cut fiscal deficit, which might in turn lower the current account deficit, and speed up reforms. The first day of the winter session of the parliament was adjourned due to unruly behavior by politicians – the day the rupee crashed to an all time low. 

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