Along with oil, threatens India’s great macros
The sharp fall in the value of the rupee to levels of 64.24 in intra-day trading on Thursday once again underscores how vulnerable the Indian currency can be to even relatively small outflows from the bond and equity markets. While $1.8 billion flowed out of equity and debt markets in the last 10 trading sessions, this has to be seen in the context of FII holdings of $380-385 billion in debt and equity markets. The $1.8 billion outflow caused the rupee to plunge from 62.85 to the dollar on April 21 all the way to 64.24 on May 7. The movement suggests anticipation of further outflows; the sharp sell-off in stocks could well continue as some of it is part of an emerging markets trend, though local factors like weak earnings and tax-related issues are dominating trading right now. The bigger worry, from the point of the view of the economy, would be the possibility of a somewhat larger current account deficit (CAD) than currently expected, following from a wider trade deficit, and also chances of higher inflation than anticipated right now. Indeed, a strong macroeconomic environment—benign inflation and a contained CAD—is what has helped hold up confidence levels over the past year at a time when industrial output has stagnated. Any disruption on this score would reduce comfort levels significantly even if forex reserves are at all time highs, and climbing. Even the fisc will be impacted since, rough estimates are, every $1 hike in crude prices raises under-recoveries on LPG and kerosene by R1,100 crore and every one rupee fall in the currency’s value to the dollar causes under-recoveries to rise R1,900 crore—the budget was based on $65 crude levels and assumed a dollar value of 60 rupees.
Already, rising prices of crude oil—currently at levels of $68/ barrel—are cause for concern and the trade balance for FY16, estimated at close to $125 billion, is predicated on shrinking imports of petroleum. In FY15, imports fell 0.6% y-o-y largely led by a 16% decline in petroleum imports. Should the import bill come in significantly higher than estimated, it would surely impact inflation, more so if the monsoon is weak, and constrain Reserve Bank of India’s attempts to lower interest rates and stymie the recovery in the domestic economy. The silver lining, of course, is that though even US recovery is patchy, the FY16 exports target could be surpassed. For one, the value of oil exports will rise—excluding petroleum, exports in FY15 were up an anaemic 1.5%. Two, with the rupee more rightly valued, this should help make exports more competitive—when the rupee traded at levels of 62.50, it was overvalued by 13.4% against a basket of 36 currencies. How much this will help is not clear since it is true global growth is bigger driver of exports growth. While predicting price trends is both futile and foolhardy, the government needs to have a plan ready since the impact of a volatile rupee can only be deleterious—more so for a largely unhedged corporate India.