Pace of rupee depreciation may slow down

The Indian rupee has depreciated around 19 per cent from the level of 43.85 recorded on July 27. Depreciation of such magnitude in just four months is formidable. The rupee has been the worst performing currency amongst its peers in the emerging market as also among other Asian currencies.

The reasons for this sharp depreciation are many. The deteriorating economic environment in Europe with the chances of the contagion spreading to other countries is the prime factor causing this decline.

Due to the deteriorating economic environment, money which foreign investors were to bring into our country has since found its way into the US treasuries which is still considered a safe haven.

Indian corporates who were expecting rupee to appreciate to 42 levels once the level of 43.97 was broken continue to have unhedged imports and dollar borrowing positions. The rupee's slide against the dollar has caught many importers unawares as they did not limit their currency risk by booking forward dollars. Many are still waiting for the market to correct and the rupee to strengthen but they may not get a chance in the short term.

Unexpected and rapid

Neither companies nor banks, which advise them, anticipated the sudden slide in the rupee. Many firms have been complacent and did not want to hedge loans and imports at the appropriate level. In the absence of appropriate risk management strategies or non-adherence to it, layers of stop losses are being triggered and some companies' balance sheets are now in duress. The fall was so unexpected and rapid, and even companies that follow a consistent hedging policy could be hit.

Dollar purchases by oil companies (refiners) to pay for the Iran liabilities accumulated in the nine months prior to July to the tune of €5 billion which was to be cleared by September, is contributing to the downward pressure.

Huge Short positions

Short dollar positions of exporters who sold at 47-48 levels expecting rupee to appreciate back to 44 levels is another factor that is currently at play in pulling the Indian currency down. Overall, the impact is that huge amount of short dollar positions have been created due to uncovered positions of importers and short dollar positions of exporters.

The government of India too has to buy dollars for interest payments, defence deal payments and so on. Due to the above, NDF arbitragers are having a field day by creating long dollar positions in the domestic market and shorting it in the overseas market to encash on the arbitrage opportunities.

To add to the rupee's woes, inflows have been meagre as exporters are reluctant to sell forward expecting more depreciation in rupee. RBI has generally been inactive in the market except very recently and is just trying to control the volatility and not the direction.

Dollar buying spree

Why the dollar buying?

Once 48.50 was breached importers became panicky and started covering their near-term imports. Oil refiners (including the private ones) have been continuously buying on a daily basis. (IOC's monthly demand for crude oil is $4 billion). There was also a news of Central Government buying an amount of $10.4 billion for fighter aircrafts which is, however, spread over a period of 1-2 years.

There are also redemptions of ECBs and FCCBs which is putting pressure on both dollar and rupee. Due to the recent paucity of dollar funds, a number of corporates have been required to liquidate their dollar borrowings to replace the same with rupee loans. This has also resulted in taking the level from 48.50 to 52.30 currently.

Trade deficit

The surprising trade deficit figures of $19.9 billion in the month of October which was seen after a gap of about 17 years has troubled all. The current account deficit, accordingly, is seen to grow from 2.6 per cent of GDP to around 3.25 per cent. Exports which were growing at a pace of more than 40 per cent till September have shown a growth of just 10 per cent in October.

The Central Government still expects an export turnover of $300 billion by the end of the year, but this will not be sufficient to cover the trade deficit which could soar to $150 billion by the end of this calendar.

Thus the macro economic parameters of the country on the export front have worsened. Already we are dealing with a long period of inflation which has been stubbornly above nine per cent for the past 11 months.

The crossing of psychological 50-level mark has triggered more buying from unhedged importers while exporters are still sitting on sidelines.

What next?

The Central Government and RBI would be very uncomfortable with the pace of the rupee depreciation which has not only dented corporate profits but has also increased imported inflation (in the form of costlier oil and foodgrains).

The rupee has already breached the previous closing high of 51.95 and if the current contagion in Europe continues to spread even further and if RBI does not start to sell dollar or take other steps to stop the dollar outflow, we could see new highs for the rupee.

Breaching of 52.20 has invited more panic buying from importers and now technically rupee reaching a level of 55.00 cannot be ruled out. However, RBI has supported the rupee near 52.73 levels and there has been less buying of dollar by importers while exporters have started selling to hedge their receivables.

RBI has also taken some policy initiatives such as hiking the ECB/Buyers Credit borrowing rate, removing the banks' swap cap from $100 million earlier. Further, the Central Government has also started taking important policy decisions in the form of allowing 51 per cent FDI in multi-brand retail and 100 per cent FDI in single-brand retail.

RBI could also allow oil companies to directly buy dollars from it thus bringing off the pressure on rupee though it has still not taken any decision on this front.

Therefore, the pace of rupee depreciation should slow down. Since 49 has now become an important support, importers should keep buying the good dips to hedge their imports of at least the next six months. Exporters, looking to the RBI's discomfiture may sell here targeting 50.80 levels in the short-term with a stop at 52.75.

Given the rapidly changing global dynamics the forecast can alter quickly.

(The author is Vice-President, Mecklai Financials. The views expressed here are personal)

COMMENT NOW