While the high current account deficit (CAD) has been considered a cause for concern, and a drag on the Indian rupee, the link between a weak Indian rupee and a high CAD does not seem to be that well established, according to a study by a Barclays affiliate.

As the Indian economy shows signs of slowing down, it expects CAD to come down during the current fiscal compared to the previous year because of fall in imports.

In its India Equity Strategy report dated September 7, Barclays Research, which is a part of the Corporate and Investment Banking division of Barclays Bank PLC (Barclays), said an analysis of the data over 15 years revealed that the INR has “limited long term correlation” with CAD.

In fact, the rupee could be “more dependent on GDP growth, inflation or capital flows”. Stating that the rupee could be under pressure for some time because of the global factors, Barclays chose to put its bet on companies with large export income even while remaining cautious on companies with a large chunk of foreign debt.

Explaining its conclusion on the limited link between CAD and INR, the Barclays report pointed out that when the current account deficit of 1.3 per cent turned into a 1.2 per cent surplus during 1998-2003, the rupee dived 30 per cent during the same time span. However, when the 1.2 per cent (current account) surplus turned to a -1.3 per cent deficit during 2003-08, the INR moved in the opposite direction- appreciating 17 per cent!  

The report said aided by the relaxation of FII limits on government bonds, FII debt inflows surged $29 billion in the past five years. But now the cost of owning government bonds (LIBOR + hedging cost) was nearly equal to the yield on government debt. 

Barclays report said India was vulnerable to import of gold and high crude oil prices and its CAD was tied to both. India’s gold imports peaked at an all-time high of 1,034 tonnes in FY11 against the average imports of 729 tonnes/year over FY 1999-2010.  This surge was due to a rise in inflation, low real interest rates and a global rally in gold prices. Gold accounted for 11 per cent of India’s import bill in FY2010-12, as against 7 per cent in FY2000-08. 

That the country’s CAD was also linked to crude oil prices was confirmed in FY12 when a 31 per cent spurt in crude oil prices led to a 54 per cent jump in the net crude import bill. The CAD rose to an all-time high of 4 per cent. Barclays noted that in 1Q of FY2012-13, the trade deficit fell 13 per cent year on year, primarily because of the decline in gold imports.

Apparently, the government decision to increase duty on gold had tempered demand for the yellow metal. 

There was also fall in the non-oil and non-gold components of imports by 3 per cent in 1QFY13 (compared to the 25 per cent increase in FY12), “indicating that some of the lumpiness of the past years could smooth out in FY13”.  The expectation was that the slowdown in economy might lead to a decline in imports which might lead to a correction in CAD in FY13 compared to the previous year.

Barclays said that companies in the metals, mining and capital goods space that have high exposure to foreign costs would be vulnerable to the currency fluctuations. It mentioned SAIL, JSW Steel, Siemens, ABB and Alstom T&D India which have high net foreign costs (due to high imports) as a percentage of total revenue and hence could be impacted negatively because of rupee depreciation.

But companies with a strong export bias, particularly those in the IT and pharma sectors, could gain from such a currency depreciation and mentioned TCS, Infosys, HCL Tech and Dr.Reddy’s, apart from Sesa Goa which exports iron ore, as those that would benefit.

Also companies with high foreign debt — JSW Steel, Jaiprakash Associates, Tata Steel, L&T (stand alone) and Reliance Infra, for instance — also needed cautious dealing because of their vulnerability to rupee depreciation “due to low natural business hedges”, the report said.

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