In deference to the popular debate and pronounced concerns
over sharp depreciation in INR value versus
US dollar, we thought it
appropriate to begin this series with a simplistic
view and outlook of INR.
Portfolio investment of few billion dollars may not have
any lasting impact on the exchange rate.
We do not expect any meaningful rise in inbound FDI till
the new government takes charge and spells new rules of the game. This may take
at least 15months.
Bharti and HUL transactions may though help a bit in short
term, provided RIL or some other entity does not make a large overseas
acquisition.
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 are 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
(a)
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 as the domestic supply has failed to meet the burgeoning consumption
demand. A large part of this demand has in fact been generated through massive
government social spending and failure to rationalize fuel and food subsidies.
The imports and therefore demand for USD is mostly inelastic to economic
growth.
On the other hand the composition of exports has changed in favor
of engineering goods, from dominantly consumer goods (tea, tobacco, leather,
spices, textile, jewelry etc.). This has increased the correlation of exports
to global growth which is not likely to improve dramatically in near future.
(b)
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.
(c)
Serious infrastructure and procedural
constraints have impacted India’s export competitiveness especially relative to
China, thus resulting in slower exports growth.
Cyclical reason
(d)
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
(e)
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.
In our view, we shall see correction of speculative and cyclical
fall in INR over next 6months. In 2014 INR shall stabilize in 52-54 range.
Thought for the day
“My mother wanted us to understand that the tragedies of
your life one day have the potential to be comic stories the next”.
Nora Ephron (1914-2012)
Word of the day
Spang (adv):
Directly, exactly
(Source: Dictionary.com)
Shri Nārada Uvāca
Jairam Ramesh finds Rohan Murthy entry into Infosys ‘a
conflict of interest’!
What about Rahul Gandhi’s appointment as Congress VP?
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