Indian currency
In our view, we
shall see correction of speculative and cyclical fall in INR over next 6months
and then a gradual depreciation over many years till we are able to correct
structural reasons. The depreciation should mostly correspond to CAD and inflation.
Last week the finance minister appeared totally flabbergasted by
the violent depreciation of INR. We agree with his current assessment that INR
may be undervalued at this point in time. But the mute questions are “is this
undervaluation without reason?” and “is it sustainable?”
Conceptually, like any other tradable thing, the exchange values
of a currency vis a vis other
currencies depends on the relative demand and supply of these currencies at any
given point in time.
The recent sharp depreciation of INR vs. USD in recent months
indicates that the demand for USD vs. INR has sharply outpaced the supply.
There could be several reasons for this higher USD demand versus INR. For
simplicity, we may classify these reasons in three categories (a) structural,
(b) cyclical and (c) speculative. Some examples are as follows:
Structural reasons
·
There have been some significant changes in the
composition of foreign trade of India in past one decade or so leading to
structurally higher demand for USD.
The structure of our imports has
changed in favor of consumer goods. (A large part of this demand has in fact
been generated through massive government social spending and failure to
rationalize fuel and food subsidies.) On the other hand the composition of
exports has changed in favor of engineering goods, from dominantly consumer
goods. This has increased the correlation of exports to global growth which is
not likely to improve dramatically in near future.
·
A spate of scams, scandals and policy flip flops
in past 5-7yrs have seriously dented the credibility of the Indian political
establishment and administration. This has certainly led to increase in risk
premium for INR denominated assets. Besides this has also prompted higher
outbound FDI. There is nothing to suggest that this trend will reverse in near
future.
·
Serious infrastructure and procedural
constraints have impacted India’s export competitiveness especially relative to
China, thus resulting in slower exports growth.
Cyclical reason
·
Persistently high inflation and huge fiscal
deficit has led to higher rates and therefore higher value of INR in past few
years. With inflation easing and fiscal deficit in control, the interest rates
are forecast to come down. This may adversely impact capital inflows and therefore
BoP. The recent sharp fall in INR could be attributed to this factor alone.
Speculative reason
·
The Fed Chairman’s recent remark about tapering
of QE has led to widespread speculation about rise in US bond yields and USD
value. This has led huge speculative short positions in EM currencies
(including INR), that have seen large USD inflows in recent years, anticipating
outflows.
What is ailing Indian economy and financial markets?
·
Part
– I
Thought for the day
“The best way to find out if you can trust somebody is to trust them.
- Ernest Hemingway (1899-1961)
Word of the day
Probity (n)
Complete and confirmed integrity; uprightness.
(Source: Dictionary.com)
Shri Nārada Uvāca
Will diesel prices hike by Rs. 8/ltr rationalize consumption and promote energy efficiency?
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