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December 30, 2011

Indian Rupee: Weakness to persist

Currency Special
Key points
 Rupee among worst performers: After falling by 20% in the last five months, the Indian
Rupee (INR) has turned out to be one of the worst performers among the major currencies
vs the US Dollar (USD).
 Both global and domestic factors contribute to weakness: The reasons that have led
to a sharp decline in the Indian Rupee can be classified under two major categories:
A. Global factors boosted the US Dollar due to the following reasons:
a) Demand for USD driven by its rising risk of sovereign debt crisis in Europe. Thus,
there is a shift away from the Euro to the USD despite the sluggish growth in the US
economy.
b) In addition to the fragile global economy, the stubbornly high inflation and moderating
growth in emerging markets are also hurting sentiments and boosting demand for
the USD.
B. Intrinsic weakness of the domestic currency: This weakness is coming mainly from
two factors
a) Deterioration in the fiscal health with a much higher than expected twin deficits
(fiscal and current account) of the country.
b) Capital outflows due to slowdown in the growth and risk aversion in financial markets.
 Rupee to remain weak: We see a potential threat of further depreciation of 7-8% for the
INR from the current level of Rs53.3/USD due to the above-mentioned factors. However,
the movement would be relatively restrained as the government is expected to attract
foreign inflows into tax-free bond issuances by infrastructure companies and raise
overseas borrowing by pledging assets of SUUTI (Specified Undertaking of the
Unit Trust of India).

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Indian Rupee

The aforementioned bearish factors for the Indian Rupee have been discussed below:
Decline of the Indian Rupee
Indian Currency Spot rate movement
55
53
51

(in Rs.)

49
47
45
43
41
39
37
Sep-11

May-11

Jan-11

Sep-10

May-10

Jan-10

Sep-09

May-09

Jan-09

Sep-08

May-08

Jan-08

Sep-07

May-07

Jan-07

Sep-06

May-06

Jan-06

35

The spot Indian Rupee (INR-USD) fell from Rs43.855/USD level on 27/07/2011 to Rs54.3050/
USD on 15/12/2011.
The pair started the year at the level of Rs44.7050/USD.
1) Global factors: These factors could be categorised into two major issues as
discussed below.
For a detailed discussion on the global macro-economic scenario and sovereign debt
issues kindly refer to the Sell report on Lead released on December 23, 2011.
a) Sovereign debt issues in major economies
b) Impending slowdown in global economy
 Sovereign debt issues in the major developed economies like the US, the euro zone, and
Japan pose a risk to the global economy and are leading to risk aversion. We think that
the worse is yet to come.
 Europe The rising yields in European bonds show the impact of the debt crisis. Greeces
governments bond yield of two years rose to an all time high of 123.394% on December
15 2011.
 The euro zone sovereign debt crisis could culminate in disintegration, or else the leaders
would have to opt for enormous money printing. There is a thin possibility of outside
help.
 Japan Moodys lowered the nations credit rating in August. Japan has got the highest
debt/GDP ratio in the world.
 The US - S&P cut US rating to AA+ from AAA on August 5 this year. US treasuries and the
US Dollar Index rallied despite the downgrading, which reflect the role and strength of
the USD.

currency special

Indian Rupee

The US Dollar Index is up 7.04% since the S&P cut the US credit rating.
Strength in DXY: As a safe haven (up nearly 10% since May 2011)
Dollar Index movement
100
95
90
85
80
75
70
65
Sep-11

May-11

Jan-11

Sep-10

May-10

Jan-10

Sep-09

May-09

Jan-09

Sep-08

May-08

Jan-08

Sep-07

May-07

Jan-07

Sep-06

May-06

Jan-06

60

b) Worsening global macroeconomic scenario means the US gains Focus on slowdown

in BRIC (Brazil, Russia, India, China) nations, recession in Europe
 The global economy is in a fragile state as the euro zone slips into a recession, China
and other BRIC nations witness a slowdown and as the US economy faces a risk of
falling into a recession next year.
 The GDP in the four BRIC countries rose at the slowest pace in almost two years last
quarter.
 The average economic growth in the BRIC countries will decelerate to 6.1 per cent
next year from a high of 9.7 per cent in 2007, according to September estimates by
the International Monetary Fund. That would narrow the gap over Americas expansion
to 4.3 percentage points, the smallest since 2004, the International Monetary Fund
(IMF) data shows.
 BRIC funds recorded $15 billion of outflows this year as the MSCI BRIC Index sank
23%, EPFR Global data shows. The gauge, which beat the S&P 500 by 390 percentage
points from November 2001 through September 2010, has trailed the measure for
five straight quarters.
 Chinas growth is getting affected due to slowing exports to Europe and government
restrictions on real-estate investment. Indias growth has been hampered by the
fastest interest-rate increases since 1935 and the rupees decline to a record low,
amid high inflation. This has deterred foreign investment in the nation. Brazil and
Russia face risk due to falling metals prices and slowdown in China.
 Chinas GDP forecast of 2011 has been cut to 9.2% from the previous forecast of
9.4% while growth forecast for the next year is around 8.00%. Chinas GDP in the
first three quarters slowed down to 9.4% as compared to 10.4% (year on year [YoY])
in 2010.
 European banks facing Dollar funding stress: The cost for European banks to fund
in dollars rose to the highest in three years in November as the euro- regions debt
crisis worsened. Gold lease rates turned negative in November as the European
banks rushed for the US Dollar leasing out gold.
3

currency special

Indian Rupee

 Dollar benefits on being the global reserve currency: Nearly two-third of the global
trade is conducted in the US Dollar.
 The US Net Treasury International Capital (TIC) long-term inflows increased to
$54.040B in September 2011, the highest level in 12 months, which shows demand
for US assets, which in turn spells bullishness for the greenback.
US Long-term Treasury International Capital Inflows

Performance of major currencies vs the US Dollar

Currency

January

As on Dec. 28

Change (in %)

INR

44.715

53

-18.53

Euro

1.3361

1.3072

-2.16

GBP

1.5489

1.5685

1.27

JPY

81.7400

77.6100

5.05

AUD

1.0291

1.0192

-0.96

CAD

0.9938

0.9835

-1.04

NZD

0.7734

0.7774

0.52

CHF

0.9334

0.9332

-0.02

CNY

6.6070

6.3256

4.26

RUBLE

30.5520

31.6600

-3.63

PESO

12.2488

13.9676

-14.03

REAL

1.6472

1.8590

-12.86

RINGGIT

3.0638

3.1690

-3.43

8988.0000

9175.0000

-2.08

BAHT

30.0800

31.4600

-4.59

SGD

1.2848

1.2937

0.69

1126.2500

1156.0000

-2.64

RUPIAH

WON

currency special

Indian Rupee

Among all the major currencies as depicted in the table given above, the Indian Rupee has
declined and fared the worst in the past 12 months. The domestic currency is one of the top
most losers among world currencies, second only to South Africa's Rand.
The fact that the Indian Rupee has performed even worse than the European currencies
speaks volumes about the weakness in the domestic currency.
2) Local Factors Focus on twin deficits, capital flows, inflation
1) Indias trade deficit can worsen
Indias trade deficit of $19.60 billion recorded in October this year is the widest in the last
17 years, while the overall trade deficit for April-October 2011-12 was estimated at $93.69
billion, which was higher than the deficit of $85.65 billion during April-October, 2010-11.
India merchandised Trade Balance

in ($ /mln)

Sep-11

May-11

Jan-11

Sep-10

May-10

Jan-10

Sep-09

May-09

Jan-09

Sep-08

May-08

Jan-08

Sep-07

May-07

Jan-07

Sep-06

May-06

-5000

Jan-06

-10000

-15000

-20000

-25000

Significance of crude oil prices - With nearly 80% of the nations crude oil requirements met
by imports, the oil import bill has climbed steeply from $79.55 billion in 2009-10 to $106
billion last year. Selling pressure on the Rupee has accentuated as Indian oil refiners bought
US dollars.
Indias crude oil imports during October were valued at $10.08 billion, up 20.73% from
$8.35 billion in the same month last year. This fiscal year so far until October 31, Indias oil
import bill grew 40.82% to $81.92 billion as against $58.17 billion in the corresponding
period last fiscal.
Indias state-owned refiners are borrowing the most dollars on record as the rupees slump
makes oil imports more expensive while local borrowing costs remain near three-year highs.
Firms can save 300 basis points by borrowing dollars, according to Indian Oil Corp., which
paid 9.28% on five-year rupee debt this month.
Yields on AAA-rated five-year rupee corporate bonds are currently at 9.52%, 269 basis
points more than the average dollar yields for Indian companies, according to data compiled
by Bloomberg and HSBC Holdings Plc.
Refiners are under pressure from all sides, making this an extremely challenging time for
them, K. Ravichandran, co-head of corporate ratings at ICRA Ltd., the local affiliate of
Moodys Investors Service, said in an interview on December 22. Crude-oil prices have
gone up, the rupee has dropped and their debt and its cost are increasing. Theyll continue
to prioritise dollar funding because thats cheaper.

currency special

Indian Rupee

Average oil price assumed at the time of budget was $90/Bl for this fiscal.
Brent Crude Prices
150

(in $/brl)

130
110
90
70

Nov-11

Aug-11

May-11

Feb-11

Nov-10

Aug-10

May-10

Feb-10

Nov-09

Aug-09

May-09

Feb-09

Nov-08

Aug-08

May-08

Feb-08

Nov-07

Aug-07

May-07

Feb-07

Nov-06

50

Indias oil import bill was $106 billion in 2010 at average Brent crude oil price of $85. This
year the average price of Brent crude oil has been around $110 so far.
Overall demand for dollar from oil importers at year-end remains noticeable.
Rising crude oil prices threaten to widen the trade deficit further.
View on crude oil prices Crude oil market remains in balance. Going forward we expect
the Libyan output to be fully restored in the next six months, hence we can expect downward
pressure on crude oil prices considering the fact that the global economy doesnt look very
strong. However, the US and Europe striving to impose sanction on Iran over its nuclear
program give rise to the possibility of a huge event risk.
Iran produces around 3.56 million barrels per day, while the spare capacity available with the
OPEC stands at 3.19 million barrels per day. Thus, in case of Iranian supply going off the
market crude oil prices can surge violently. It is to be noted that non-OPEC nations dont have
spare capacity. Crude oil prices can jump 30% to 50% should Iran attempt to play its oil card.
2) Fiscal deficit likely to escalate
India Govt Fiscal Deficit
110000
90000

50000
30000

Sep-11

May-11

Jan-11

Sep-10

May-10

Jan-10

Sep-09

May-09

Jan-09

Sep-08

May-08

Jan-08

Sep-07

May-07

Jan-07

-30000

Sep-06

-10000

May-06

10000
Jan-06

(in Rs/Crores)

70000

-50000
-70000

currency special

Indian Rupee

 India's fiscal deficit widened to Rs3.07 trillion during April-October 2011 from Rs2.92
trillion until September, as revenue flows remained sluggish even as spending continues
at a brisk pace, as per Controller General of Accounts.
 The deficit during April-October works out to just over 3.4% of GDP compared to 4.6%
target for the full year 2011-12 (April-March).
 The revenue deficit was at Rs2.43 trillion until October, or 79.1% of the budget aim.
 During April-September, total expenditure was Rs6.8 trillion, while receipts stood at
Rs3.73 trillion leaving a fiscal gap of Rs3.07 trillion.
 Oil firms are required to sell fuels below cost under a government plan to cap consumer
prices. The firms may lose as much as 1.3 trillion rupees from such sales in the financial
year ending March 31, Oil Secretary G.C. Chaturvedi said on November 22. The three
biggest refiners reported a combined loss of 141 billion rupees for the three months
ended September 30, the most on record.
 Every one-rupee drop in the Indian currency against the dollar boosts annual revenue
losses for government-owned refiners by 80 billion rupees, Oil Minister S. Jaipal Reddy
said on October 10.
 Indias subsidy set to double in 4 years by 2012 end - The subsidy bill is projected to
double (Rs1,43,570 crore) by the end of 2012 due to increasing subsidies on petroleum
and food items. This is as per the projection given by the Indias finance minister. The
greatest share of the subsidy allocation is for the three main segments viz food, fertiliser
and petroleum.
Item

Projected subsidy

Actual subsidy in

Revised subsidy in

in 2011-12 (Cr Rs)

2007-08

2010-11

Food

60573

31328

60600

Fertilizer

49998

32490

54976

Petroleum

23460

2820

38386

Total

134031

66638

153962

Revised estimate for the current fiscal is Rs1,64,153 crore.

Dwindling growth in tax receipt: CBDT sources on December 28, 2011 stated that they may
miss FY2012 direct tax targets by Rs15,000-20,000 crore.
 Failure to raise capital through divestments: Owing to poor secondary market conditions
the government was unable to meet the disinvestment target of Rs40,000 crore for
public sector units (PSUs). So far, the government has raised only Rs1,145 crore through
the sale of its equity in Power Finance Corporation.
 Fiscal deficit can cross 5.60% in this financial year.
 Rising fiscal deficit increases the borrowings of the government, which in turn puts an
upward pressure on the interest rates, thus in turn putting a downward pressure on the
growth. This can lead to further widening of the fiscal deficit.

currency special

Indian Rupee

India's 10 year Govt Generic Bond Yield

10.5
9.5

(in %)

8.5
7.5
6.5
5.5

Sep-11

May-11

Jan-11

Sep-10

May-10

Jan-10

Sep-09

May-09

Jan-09

Sep-08

May-08

Jan-08

Sep-07

May-07

Jan-07

Sep-06

Jan-06

May-06

4.5

Indias 10-year bond yield was 8.95% in November, near its highest level since 2008 as the
government tried to sell a record amount of debt at a time when relatively faster inflation
is limiting demand for the securities.
The combination of trade deficit and shrinking confidence in the governments ability to
rein in record bond sales pushed the benchmark 10-year debt yields to 9%, the most among
Asias ten biggest economies. This brought wide currency swings in the forex market.
3) Risk to growth increasing
India's GDP (QoQ)
11
10

(in %)

9
8
7
6

Sep-11

Jun-11

Mar-11

Dec-10

Sep-10

Jun-10

Mar-10

Dec-09

Sep-09

Jun-09

Mar-09

Dec-08

Sep-08

Jun-08

Mar-08

Dec-07

Sep-07

Jun-07

Mar-07

Dec-06

Sep-06

Jun-06

Mar-06

India's economic growth in July-September was slowest in nine quarters at 6.9% (quarter on
quarter [QoQ]) as successive rate hikes choked industrial expansion. The growth has been
significantly slower than the 7.7% expansion seen in the April-June quarter.
Containing inflation top priority for RBI - The central bank has raised the key policy rate 13
times since March 2010, with effective tightening of 375 bps. Headline inflation has hovered
around the double-digit mark for 20 months despite a series of rate hikes by the RBI.

currency special

Indian Rupee

India's Monthly Inflation

18
16
14
12
in (%)

10
8
6
4
2

WPI

Sep-11

May-11

Jan-11

Sep-10

May-10

Jan-10

Sep-09

May-09

Jan-09

Sep-08

May-08

Jan-08

Sep-07

May-07

Jan-07

Sep-06

May-06

-2

Jan-06

CPI

Indias benchmark wholesale price index (WPI) based inflation has held above 9% for 11
months; it accelerated to the fastest pace among the G20 nations to 9.78% in August while
the Consumer Price Index (month on month [MoM]) has already reached double digit levels
ie at 10.1%. Higher oil prices fanned inflation. This high inflation is hurting the sustainable
growth prospects. Weakening currency adds to the adding inflationary pressure.
The central bank remains vigilant against the inflationary expectations, which means that
monetary policy easing to stimulate growth could be delayed.
4) FII Inflows negative in 2011
 India has seen net foreign institutional investor (FII) outflows of $480 million this year
as on December 28. This is in sharp contrast to a net inflow of 29.32 Billion Dollars in
2010.
 The currency needs more stable global risk factors to benefit from supportive capital
flows. With rising risk aversion and slowing growth, that appears to be a low probability
case.
India Net FII in Equity

2000
1500

in ($/mln)

1000
500

Sep-11

May-11

Jan-11

Sep-10

May-10

Jan-10

Sep-09

May-09

Jan-09

Sep-08

May-08

Jan-08

Sep-07

May-07

Jan-07

Sep-06

May-06

-500

Jan-06

-1000

currency special

Indian Rupee

The benchmark 30-share index, the Sensex, fell to 15135 on December 20 the lowest level
in the year 2011- as investors pulled out funds from emerging markets on concern that the
euro-zone crisis may deepen as the Standard & Poor's and other rating agencies prepare for
more downgrades.
Sensex
25000
20000
15000
10000
5000

Sep-11

May-11

Jan-11

Sep-10

May-10

Jan-10

Sep-09

May-09

Jan-09

Sep-08

May-08

Jan-08

Sep-07

May-07

Jan-07

Sep-06

May-06

Jan-06

Since the start of this year the Indian market has fallen 21.62% as on December 27, while
global equities are down 9.09% in the same period.
Steps taken by the RBI and the Government of India to lessen the pressure on the
currency
RBIs current stance is to limit the volatility in the currencies market.
a) Forward contracts once canceled cannot be bought again.
b) Foreign investors can roll over forex contracts before maturity.
c) Foreign investors can't book again forex contracts once cancelled.
d) The RBI said companies cant enter into multiple forward contracts to cover a single
overseas transaction.
e) The central bank also said it will reduce the amount of open positions dealers can maintain
overnight. It would increase the transaction cost for the dealers.
f) The RBI eased rules in November for companies to borrow abroad and sell foreign
currencies through swaps and raised the interest rate on bank deposits for Indians
living overseas.
SUUTI pledge: The government is considering pledging the assets of SUUTI, or the specified
undertaking of UTI, to raise funds for buying the government equity in state-owned
companies. The move is expected to fetch the government enough money for meeting its
disinvestments target of Rs40,000 crore in FY2012.
Global financial services major Bank of America Merrill Lynch said in a report dated December
28 that a fiscal engineering exercise like pledging of SUUTI shares will only provide a bit of
fiscal relief as higher oil subsidies is expected to play a spoilsport. "We still expect Delhi to
overshoot its budgeted 4.6% of GDP fiscal deficit target by over Rs1,000 billion on higher
oil subsidies," the report said. The Bank of America Merrill Lynch has cut its FY2012 target
for the Indian government's fiscal deficit by 30 basis points to 5.8% of GDP.
10

currency special

Indian Rupee

Impact of steps taken by the RBI and the government - The Indian Rupee corrected nearly
4% after the steps taken by the RBI; however since then the Rupee has been inching mostly
lower.
RBIs stance on intervention RBI aims to control the volatility and has been mostly
intervening intermittently to break the momentum of the USD rally. However, the central
bank is not trying to reverse the trend as intervention is unlikely to work due to limited
reserves; also interventions rarely work in a huge market like foreign exchange, especially
when there are major factors at play. Hence, interventions by the RBI are unlikely to change
the major trend of the currency.
Risk to our bearish view on the Indian Rupee Following factors can threaten our overall
bearish view on the domestic currency:
1) The US Fed embarking on the third round of quantitative easing should the US economy
weaken significantly.
2) The euro zone resorting to massive money printing to contain the crisis. However, with
Germanys stand against that very idea and risk of moral hazard in the otherwise
dilapidated global financial system, the possibility is really low as of now.
3) The Indian government moving faster than expectations on reforms and disinvestments.
Conclusion - Another 7-8% decline looms
 The sharp decline in the INR below the 2008 level (Rs52.18/USD) is alarming as the
currency is faring the worst among its major peers; steps taken by the RBI dont seem
to have much impact on the currency.
 The European zone sovereign debt crisis and high oil prices are the biggest threats to
the Indian Rupee.
 Inflation is likely to moderate to 7% by March; however the global scenario remains
highly uncertain, hence downside risk to the Rupee would persist.
Target - The Indian Rupee can decline to Rs55.20/USD in the next six months. The downside
can extend to Rs57.10/USD in the next nine to twelve months.
We have generated a buy call on the US Dollar on December 28 at Rs53.30 level for a target
of Rs57.10. The timeframe is six to nine months.

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11
currency special
mentioned.
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