India: a sliding rupee in a frozen system | FT Alphaville

India: a sliding rupee in a frozen system

“Bas! Bas!” is surely a familiar cry in the Reserve Bank of India right now as India’s rupee continues to plummet. So far, it has dropped 15 per cent against the US dollar since the start of February, hitting multiple new record lows on its way.

The central bank has attempted to get inventive in response but nothing seems to be stopping the slide (metaphorically speaking, in the chart, the higher it gets the weaker the rupee):

The rupee’s dive in value is mirrored by that of the Sensex, India’s benchmark index, which is approaching its lowest level of the year:

And the 12 month non-deliverable forward market is pricing in a move towards Rs59.5, implying a further fall to come.

Although the risk-off dive in the global economy isn’t helping at all, India’s economic problems are very real. Its fiscal, trade and current account deficits are widening, growth is sluggish, inflation remains buoyant (not surprisingly considering India imports 80 per cent of its crude oil) and foreign direct investment is slowing markedly.

Standard Chartered expect growth to have slowed even further, to 6 per cent year-on-year in the quarter ended 31 March from 6.1 per cent the previous quarter, thwarting initial market expectations of an improvement to 6.5 – 7 per cent:

And since recent slowdowns prompted the RBI to cut rates by 50bps at its meeting on April 17 — not a rupee positive move or one designed to hold inflation back — there is a small chance of further measures being taken (although the latest RBI missive suggested the ball was firmly in the government’s court now and inflation appears to have picked back up):

Meanwhile, the more *inventive* measures being taken by the RBI to stabilise the rupee are just not working. It has tried forcing exporters to sell half of their foreign currency, curbed trading in currency derivatives and floated the idea of selling dollars directly to oil importers… all with little effect.

(To keep things spicy, Benoit Anne at SocGen thinks that to avoid serious losses of credibility, there are increasing risks of more drastic RBI measures in the days ahead.)

And it is worth remembering that India’s current account deficit is also intimately tied to oil and, to a lesser extent, gold. As mentioned India imports 80 per cent of its crude oil comprising 30 per cent of its import bill while gold takes up 10 per cent. That has sent India’s current account deficit souring along with prices and demand:

(It should be noted that a change in the oil price in particular could kick-start a virtuous cycle.)

But, it is obviously not the current account deficit alone which is kicking the rupee. From HSBC:

True, the current account deficit is reasonably large at roughly 3 to 4% of GDP. But we have been reluctant in believing that just because India has a current account deficit that the currency should be weak. This is because it is underperforming others such as the PLN and TRY which also have large current account deficits.

That same point is made by Citi’s Rohini Malkani:

What is more concerning is its performance relative to other EMs. As we have mentioned earlier, when gauging the performance of the INR its important to view itrelative with other countries facing a CAD, such as the Turkey, South Africa, Brazil, etc.

More important, say the analysts, is at what level the deficit can be funded and by what type of inflows. And with FDI inflows slowing, an increasing reliance on more volatile portfolio flows and the external backdrop very definitely risk adverse, there is little solace on that front.

So, in order to provide the rupee with some measure of protection the RBI has been burning through its cash reserves faster than Nokia. From Bloomberg Wire (with our emphasis):

Foreign-exchange reserves in Asia’s third-largest economy have slid $29 billion from a record in September as central bank Governor Duvvuri Subbarao used the stockpile to slow rupee declines amid fund withdrawals by foreign investors…

“India is paying the price to protect the rupee by using the reserves and therefore is creating an imbalance that will be difficult to sustain,” Robert Carnell, chief international economist at ING Bank NV, said…

The Reserve Bank of India sold a net $20.1 billion in the seven months through March, the latest data on its website show…

Reserves fell $17.1 billion in the six months through March 31 in India, the most since the global credit crisis of 2008, while they rose $15.5 billion in Brazil, according to official data. China’s holdings surged $103.3 billion in the period and Russia’s declined $6.8 billion. India’s $291.8 billion stockpile is enough to pay for seven months of imports, Finance Minister Pranab Mukherjee said May 16…

“The RBI has been forced to unveil an increasingly desperate series of ad hoc measures designed to stimulate short- term inflows,” Richard Iley, the Hong-Kong based chief economist for Asia at BNP Paribas SA, wrote in a research note dated May 21. “The RBI’s ability to stem the selling pressure on the rupee in the short term is relatively limited.”

And now many are suspicious of  the RBI’s continuing ability (or potential willingness) to protect the rupee particularly as the current account deficit has kept FX reserves down. From HSBC again:

What also appears to be working against the INR is some tentative evidence of a change in FX policy…

During the period of intense INR weakness from October to December 2011, RBI was seen actively trying to limit the sharp move higher in USD-INR. Over those three months India’s headline reserves fell by $23bn, with our estimates of actual intervention very similar to this…

The scale of this (nearly 10% of FX reserves were sold) clearly pointed to authorities being concerned with excessive weakness in the currency. In February, the RBI appeared to be buying USD (if only a marginal amount), despite the fact that USD-INR did not appear to be under great pressure to move lower. Meanwhile, in March, when INR depreciated over 4%, the RBI was even less active in the market. This points to a shift from previous periods of sharp INR weakness.But it may also be that the RBI is somewhat constrained in limiting currency weakness in theway that it used to due to other onshore issues.

That leaves it to Delhi to restore some faith in the India growth story, attract some investment, and thus support the rupee. The RBI, market watchers, newspapers and commentators generally have been yelling for the Indian government to take “bold measures”.

However, say Citi analysts argue, most investors think an ongoing policy paralysis and ‘governance’ deficit is the key reason for the slowing India growth story:

Key concerns centered on in-ordinate delays in project approvals, fuel supply issues and controversies surrounding foreign investment – GAAR, telecom, gas pricing. Moreover, Congress’s diminishing popularity has meant that it is likely playing it safe and staying away from big-ticket reforms.

Supply-bottlenecks coupled with a lack of policy thrust have hindered investments. Execution-related challenges are resulting in an increase installed projects – which increased 91% QoQ and 27% YoY in 4QFY12 (private projects being particularly hard hit). While funding constraints have resulted in subdued private sector investments, we believe that the onus is on the government to resolve supply bottlenecks

But the Indian government is locked in what is lovingly called “stasis”. From a recent Economic Times editorial (with out emphasis):

Unfortunately, the real problem of the UPA II [India’s current ruling party] cannot be measured in graphs, charts and ratios. This problem is its lack of conviction, or will, to govern meaningfully.

It probably started losing its nerve by the autumn of 2010, when allegations of graft were levelled at the organisers of Delhi’s Commonwealth Games, and it continued to flounder as such allegations continued to pour out month after month.

Even after sending politicians and ministers to jail, the administration did not seem to get its act in place. Today, when people grumble about policy paralysis, what they are actually trying to say is that the administration looks headless, with senior ministers having an opinion on everything, but doing little.

In that case, the government needs a shake up, soon.

Unfortunately, with national elections looming in 2014 and India’s coalition descending into infighting once more, it seems unlikely this most inactive of government will get its act together any time soon.

Related link:
India’s economic monsoon – FT Alphaville
beyondbrics – The FT’s emerging markets hub
For India’s Dominant Party, Electoral Setback Stirs Self-Doubt – NYT