CIRCUIT BREAKER. A strong rupee is not bad news

After slip-sliding all the way from 58.9 to a dollar in May 2014 to 68.7 in November 2016, the rupee has been fighting back of late. After breaking through the barrier of 64, the currency is up over 5 per cent vis-à-vis the dollar since the beginning of 2017. Not only is this the rupee’s sharpest spell of appreciation in the last few years, the currency has also outperformed its Asian and emerging market peers.

Analysts reckon that the recent show of strength by the rupee is driven both by liquidity and fundamental factors. Foreign investors have resumed their love affair with India, lured by the NDA’s recent victories. The fundamentals underpinning the Indian economy and its exchange rate are in an unusually good place too. The RBI’s unusual reluctance to intervene has also helped the cause.

So, is it good or bad if the rupee continues on its appreciating spree? While analysts and market participants are divided, an objective analysis tells us that a stronger rupee is certainly reason to celebrate.

India depends on imports for everything from crude oil to plastic toys. Hence, its merchandise import bill has been exceeding its export earnings by anywhere between $100 billion and $130 billion in recent years. Services exports partly bridge the gap by bringing in $60-70 billion. But with the Indian IT/BPO sector in hot water, the gap is widening.

A strengthening rupee-dollar equation can help the country pocket some neat savings on its imports. To simplify, India spent $380 billion on its merchandise imports in FY17. At an exchange rate of 68 to a dollar, this entails an outgo of ₹25.8 lakh crore. But at 64 a dollar, the bill shrinks to ₹24.3 lakh crore — a cool saving of ₹1.5 lakh crore a year.

But will a stronger rupee make Indians crave more imported products? And won’t it dull the competitive edge of exporters, reducing their shipments?

Not entirely. Fuel, industrial commodities and capital goods make up the bulk of India’s import bill, and the domestic demand for these goods is more reliant on economic activity than exchange rates. Factors such as global demand and commodity realisations play a far greater role in India’s aggregate export performance than the exchange rate.

In fact, India’s export growth accelerated sharply over February and March of 2017 (17.5 per cent and 27.6 per cent respectively) alongside the appreciating rupee. Export growth picked up to a six-year high after languishing in single digits or shrinking for the preceding 12 months. A ten-year correlation analysis shows an insignificant negative correlation of 0.02 between monthly rupee gains and export growth.

Global commodity prices have revived in the last one year, after a debilitating meltdown that lasted from 2011 to 2016. In the past year, an IMF index of industrial inputs has rebounded by 28 per cent while the energy index has shot up by 36 per cent. This price rise would, in normal circumstances, feed into domestic inflation rates on fuel, industrial commodities and manufactured products. But rupee appreciation offsets this. Take crude oil as an illustration. In end-November 2016, when the rupee was at an anaemic 68.6 to a dollar, the price of the Indian crude oil basket ruled at $44.2/barrel, an effective rupee cost of ₹3,036 a barrel. By April 26 2017, crude oil prices had risen to $ 50.4/barrel. With the rupee at 64.2, the outlay was now ₹3,240.

Essentially, fuel price inflation has been halved from 14 per cent to 7 per cent due to the rupee effect. This is good news for Indian consumers, as domestic inflation has shown runaway tendencies of late, with the WPI for February at a three-year high. More muted inflation will also mean a less hawkish RBI.

To be sure, a stronger rupee is not great news for the largest members of India Inc who have a sizeable global leg to their operations. It will reduce realisations for commodity majors and reduce export revenues for IT and pharma leaders. A report by Edelweiss Securities finds that companies with global linkages to their earnings have a 47 per cent weight in the Nifty and estimates that if the rupee strengthens to 62 to a dollar, it can shave 4 per cent off Nifty earnings for FY18.

But then, a similar equation may not hold good for the rest of India Inc. Data from Capitaline on the CNX500 companies shows that in FY16, revenue expenses in forex for these firms were 34 per cent higher than their forex earnings. Users of imported inputs, with domestic operations made up much of this universe. They will stand to gain from a robust rupee.

But more than this, it is savings on debt servicing costs that promise a larger bonanza to many members of India Inc. As of March 2016, Indian banks and financial institutions had $159 billion in foreign currency loans outstanding, while corporate India had another $150 billion in dues. That’s ₹20 lakh crore of forex-denominated debt.

In a bid to keep their interest costs low, well over half of those borrowers have left their loans unhedged against exchange risk. While a depreciating rupee has tightened the screws on them, its strength brings them substantial relief.

For long, foreign investors pouring money into India have made do with a raw deal. They’ve been forced to cede a big slice of their hard-earned returns in the country to exchange rate losses.

Domestic investors who jumped into the Sensex stocks in December 2007, a market peak, had made a 31 per cent gain by December 2016. But nine years on, foreign investors were still in the red. The Dollex 30 (which captures dollar returns on the Sensex) was trading 24 per cent below its December 2007 levels, owing to rupee-related losses.

But the tables have turned in 2017 with the Dollex 30 (20 per cent gain) overtaking the Sensex (13 per cent gain) on a year-to-date basis. If a stronger currency raises hopes for equity investors, it offers debt investors the lure of playing rate differentials, without having to hedge their currency exposures.

For the last two decades, foreign investors have kept up their love affair with India despite a weak rupee eating into their rewards. Imagine if the tide turns and exchange gains actually bolster their returns. This can set off a virtuous cycle where a stronger currency attracts more foreign flows, which in turn props up the currency further.

Now let’s just hope and pray that the recent rupee rally doesn’t turn out to be a flash in the pan.

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