Currency and its outlook

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The year 2017 was a memorable year with the rupee snapping its 6 years of decline against the US dollar to close the year on a strong note. But matters have turned different in 2018 - from one of the best performing currency to become one of the worst performing already.


The currency is down by over 2% this year. This is despite the fact that the US dollar index has been broadly range bound after having fallen sharply by 10% in 2017.


There are three major factors which pushed up the rupee in 2017:


  1. The resounding victory of the ruling BJP in the largest state of UP (recovery of INR to 64 from 66);

  2. Strong inflows from Foreign Portfolio Investors (FPI) into the Indian debt market. Relative higher yields on debt led to attractiveness of the FPI’s (2017 - second highest inflow since 2014 of USD 23 billion; March’18 alone - USD 3.92).

  3. Sustained weakness in the US dollar all through 2017 that kept the rupee stronger (dollar index tumbled from 104 in Jan to a low of 94 in sept).

What the charts say?


Is the rupee heading for a fresh fall in the coming months


To gauge where the currency is headed, let us look at the Indian macro picture:


(a.) Deficit woes: Widening Current Account Deficit (CAD) remains a worry. India’s CAD widened to USD 13.48 billion in the quarter ending Dec’2017 from USD 7.23 billion in sept’2017. The deficit for the same period in the previous year was USD 7.92 billion. The merchandise trade deficit has been bulging keeping the CAD under pressure.


According to the data from Ministry of Commerce, exports in the fiscal year 2017-18 have increased 10% to USD 302.84 billion. Imports, on the other hand, have increased at a much faster pace of 20% in the same period to USD 459.6 billion. This has taken the trade deficit wider to USD 156. 8 billion in FY 18 from USD 108.9 billion in FY 17. Two major components: surging crude oil prices and increase in gold imports – can continue to keep the imports bill higher, thereby retaining pressure on the trade deficit.


Crude oil prices have been surging since last June. The West Texas Intermediate (WTI) Crude futures contract skyrocketed over 55% from around USD 43 per barrel to the current levels of USD 67 per barrel. The Organisation of Petroleum Exporting Countries (OPEC) deciding to extend the production cut until end 2018, coupled with the geo-political risks, are supporting the crude oil price in the recent times. According to International Energy Agency (IEA), oil demand is expected to increase 99.3 million barrels per day in 2018 from 97.8 million barrels per day. The market is expected to run into a deficit in the second half of this year. There is thus, a strong likelihood of the oil prices increasing further towards USD 76 per barrel in the coming months, owing to these factors.


Gold, on the other hand, is gaining sheen from the on-going trade war concern between the USA and China. Gold imports are inching higher having fallen over the previous two consecutive fiscals. India has imported USD 28.26 billion worth of gold in FY 18 (April – January), surpassing the USD 27.45 billion imported in the entire FY 17. Gold prices remaining stable in a broad range between US $ 1200 – 1300 per ounce in the first half of 2017 coupled with dealers beginning to restock after reconverting from the impact of cash crunch owing to demonetisation, saw the surging bullion imports. Though gold prices are range bound between USD 1300-1370 per ounce since the beginning of 2018, there is a high possibility of the yellow metal surging towards USD 1450.


On an average, oil contributes 25% of India’s total imports and gold accounts for 8%. A strong surge in these commodity prices will take the import bills higher which, in turn, could widen the deficit further. This is a big negative for the rupee.


(b.) Debt and reserves: India’s external debt is another concern given that the global interest rate cycle is reversing higher. External debt has been rising consistently over the last year. As on Dec’2017, the total external debt was USD 513.4 billion, up over 12% from the previous year. Long term debt accounts for 81% and the remaining the short term. Though record forex reserve build up can come to the rescue, increasing debt will continue to be a concern. The country’s forex reserve can cover upto 10 months of imports.


(c.) Rupee overvalued: The REER (Real Effective Exchange Rate) indicates that the rupee is overvalued. REER is a measure of valuing a currency against the currencies of its trade partners. A currency is considered overvalued if its REER is greater than 100 and undervalued if the REER is below 100. As of the first week of March’2018, the 6currency trade weighted REER was at 124.56 and the 36 currency trade weighted REER at 117.38. An overvalued REER increases the possibility of the rupee weakening in the coming months.


(d.) Elections and foreign money: The rupee’s volatility is likely to stand increased going into the Lok Sabha elections in 2019. A look at the one year period prior to elections in 2009 and 2014 point to a 20% and 9% deprecation respectively.


These election years also were preceded by key events such as the global financial crisis and the US beginning to taper the quantitative easing.


The outcome of the Assembly elections in Karnataka, Madhya Pradesh, Rajasthan will be a key sentiment driver for the financial market and would influence foreign money flows into the country.


An outcome against the ruling BJP in the State elections will increase the risk of the FPI’s pulling money out of the country that could become negative for the rupee.


(e.) Final takeaway: from the above analysis of the macro economic indicators, the domestic factors seem to be unfavourable for the rupee. Higher oil and gold prices may further widen the deficit. Increasing debt and over valued REER are likely to weaken the rupee and drag it down in the coming months.


Hope you enjoyed reading this edition.


Disclaimer:


The views of the authors/publishers should not be construed as advice. Investors must make their own investment decisions based on their specific investment objectives and financial positions and using qualified advisors as may be necessary. Opinions expressed in various articles are not necessarily those of Wealthmax Enterprises Management Private Limited(WEMPL) or any of its directors, officers, employees and personnel. Consequently, WEMPL or any of its directors, officers, employees and personnel do not accept any responsibility for the editorial content or its accuracy, completeness or reliability and hereby disclaim any liability with regard to the same. Stock picks and mutual fund snapshots are not exhaustive and should not be construed as recommendations.