Wednesday, March 22, 2017

Where INR is headed

"Burn down your cities and leave our farms, and your cities will spring up again as if by magic; but destroy our farms and the grass will grow in the streets of every city in the country."
—William Jennings (American, 1860-1925)
Word for the day
Anthophilous (adj)
Attracted by or living among flowers.
Malice towards none
Why a sudden rush in media to highlight the secular credential of the Yogi?
First random thought this morning
The common market area of Europe (European Union) is looking distinctly similar to the Congress Party of India.
The people outside it are not very sure if it will survive. The people currently inside are divided. Some, primarily who have lost their niche and suffer from a relatively stronger Euro, want to leave. Some, primarily who have gained from market access and relatively weaker Euro, hope that it is a sustainable arrangement, and therefore want it to stay.
Few appear confident about its relevance or otherwise in the current context.

Where INR is headed

A lot of people have expressed their surprise as well as concerns over sharp appreciation in INR value versus its global peers, especially USD, in past few months. Many have sought my views on the likely path for INR in near future.
I want to make it clear that I am no expert in the matters of macroeconomics, foreign trade or currency trades. While I do assign a small weight to the currency impact in my investment decisions; the consideration is mostly limited to avoiding companies that are unduly impacted by currency volatility.
I also strongly believe that Portfolio investment of few billion dollars may not have any lasting impact on the exchange rate of INR. However, sustained FDI inflows do support the case for some currency appreciation.
In my view, like any other tradable commodity, the exchange values of a currency vis-à-vis other currencies depends on the relative demand and supply of these currencies at any given point in time.
In simple terms, the recent sharp appreciation of INR vs. USD in recent months indicates that the demand for INR vs. USD has sharply outpaced the supply. There could be several reasons for this higher INR demand versus USD. For simplicity, I 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 sector spending and managed Chinese currency. 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 likely to remain below par in at least for next few years.
(b)   The change in political regime in 2014 has restored the confidence of global community in Indian political establishment and therefore markets & economy. This confidence was seriously impacted by a spate of scams, scandals and policy flip flops in the preceding 5-7yrs. This has certainly led to reduction in risk premium for INR denominated assets. Besides this has also prompted higher inbound FDI. There is nothing to suggest that this trend will reverse in near future.
(c)    The efforts to improve infrastructure and remove procedural constraints are likely to help improving India’s export competitiveness and result in higher exports growth.
The structural reasons are therefore mostly in balance at this point in time.
Cyclical reason
(d)   The success of RBI's measures in reigning the runaway inflation, strict fiscal discipline and improvements in trade balance have helped lowering rates in the economy to a limited extent.
As of now, both the inflation and fiscal deficit seems to have bottomed out and accordingly RBI has changed its policy stance to Neutral from the earlier Accommodative. The interest rates are therefore not seen changing materially from the current level in very near term.
This stability has made INR assets attractive to foreign investors.
(e)    The protectionist measure taken by the government in past one year to curb imports and promote exports through various tariff and non-tariff measures have also helped the trade balance to some extent. For example, from a large steel importer, India may have turned into a net steel exporter in past one year.
(f)    The outlook of EUR is clouded by the political calendar of Europe, especially schedule for Brexit, French and German elections. This is also seen helping Indian currency that is being perceived as safe haven by many under the current circumstances.
Speculative reason
(g)    The Fed Chairman’s recent remark about the gradual trajectory of rate hikes, against the widely speculated steep hikes, has led to recovery in US bond yields and weaker outlook for USD. This has made emerging market local currency assets attractive on relative basis.
(h)   The move to abolish 86% of Indian currency in circulation is speculated to have resulted in material reduction in informal market for USD, known as hawala trade in common parlance. This is speculated to have resulted in significantly lower demand for physical dollars in Indian market, resulting in stronger INR.
On balance, I feel the current strength in INR is mostly cyclical and to some extent speculative. It may not last beyond few months, in my view. Presently, I am working with 67/USD as average exchange rate for my FY18 earnings.

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