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Since January, the rupee has fallen 7.8% against the US dollar, falling to its lowest conversion rate of 69.10 last week. At the same time, the Indian currency fell by 4.65% against the euro, by 9.7% against the yen and by 5.28% against the pound sterling.
Other emerging market currencies slipped the same way. Mbadive sales by foreign portfolio investors, or REITs, which pulled more than $ 19 billion from major emerging markets between January and June, are an immediate cause of the decline.
In India, REITs sold Rs 4,693 crore equity and Rs 41,397 crores of debt, which corresponds to net sales of Rs 46,090 crore, in the first six months of this year. In fact, they were net buyers between January and March. But since April, REITs have sold more than Rs 59, 000 crore, the highest outgoing debit from India.
Another reason for the weakening of the rupee is the growing trade deficit. India has exported goods worth $ 303 billion in 2017 -18 but has accumulated a $ 459 billion import bill. The trade deficit will worsen in 2018-1919 due to high oil prices. India has a trade surplus in services and "invisible goods", such as tourism and remittances, but its current account, which represents the difference between net foreign exchange inflows and net outflows, is in deficit. .
In 2017-18, the current account deficit reached 1.9% of gross domestic product, compared to 0.6% the previous year. In absolute terms, net outflows increased from $ 15 billion to $ 48 billion. Kotak Institutional Research did a sensitivity badysis. Assuming the Indian crude oil basket averages $ 67.50 per barrel in 2018-19, it projects a current account deficit of 2.6%. The credit rating agency ICRA estimates a deficit of 2.4%, which is in the same order of the idea.
If, as expected, crude prices rise, the current account deficit could still widen: Kotak estimates a deficit of 2.9% at $ 72.50 per barrel and a deficit of 3.3 % to 80 dollars a barrel. For the first quarter of 2018-1919, the gross basket of India worked on average at $ 72.80.
As the current account deficit widens and the currency weakens, it creates a natural barrier to imports as they become more expensive. It also makes exports more competitive.
However, India's key imports are energy products such as crude oil and gas. Indeed, more than 80% of the crude oil and 30% of the gas consumed by the country are imported. Whatever the price of crude – it has exceeded $ 100 a barrel for three years until 2013 – 14 – energy imports must continue. At the same time, a cheaper rupee may not help Indian exports gain a competitive advantage since China, Vietnam, Bangladesh, Indonesia and the Asian Tigers have seen their currency depreciate as well.
Controlling Volatility
Nevertheless, the rupee should be able to weaken as it offers a chance to rebalance trade equations. An overvalued currency with a high current account deficit is a terrible recipe. A strong rupee will increase the deficit since imports remain cheap. And when the market reacts to the imbalance, there could be a sudden collapse of the currency.
The Reserve Bank of India should focus on controlling volatility to make the rate of decline of the rupee stable and predictable rather than sudden and jerky. But the government will want a stronger rupee since costly energy imports equal higher inflation and it is a politically sensitive variable. Starting from the experience of demonetization, the RBI, which is theoretically an autonomous organization, will do what the government wants, even if it is not a sensible course of action.
Could the rupee fall further and what can the government or the RBI do?
Most traders use what is called "interest arbitrage covered" to judge whether a currency is worth buying. It goes like this:
- Convert the dollars to rupees at the current rate.
- Invest in rupee debt instruments that produce safe returns such as a 364-day Treasury.
- Calculate how much rupees you will get in
- Take a futures contract to convert rupees to dollars
- Compare dollar returns of this investment to yields of dollar-denominated debt instruments such as bonds Treasury.
Note that it is guaranteed returns and the calculation is based on data that is publicly available. Of course, traders also invest in debt and riskier equity, but that's a basic calculation. If a return on surplus is visible, traders will buy rupees until one or more of several events occur. Interest rates of the rupee may change. Interest rates in dollars may change. The forward rate could change, erasing yield differentials. Indeed, it means that exchange rates will change.
From now on, the US Federal Reserve should raise its interest rates. The RBI should do the same. US government debt is about 3% and will increase. Yield Rupee Treasury bills are just under 8%. The gap between yields in dollars and rupees has narrowed compared to six months ago. The forward rate has changed, which implies more depreciation of the rupee. Traders are therefore cautious when investing in rupee badets.
Overvalued Rupee
The RBI's own calculations suggest that the rupee is overvalued. The RBI badesses currency levels with a tool called the RRSP, or real effective exchange rate. The RRSP compares the purchasing power of the rupee to a basket of currencies, weighted by India's trade ratios with these countries. It also adjusts nominal exchange rates according to relative inflation rates in these countries. The RBI makes RRSP calculations for two baskets of 36 currencies and six currencies. Currently, both baskets indicate overvaluation.
The trading characteristics of the rupee are those of a "dirty float". It is heavily traded but not freely convertible, and the RBI can easily intervene in the forex market as well as imposing currency controls. The RBI can also ask commercial banks to offer good terms for interest bearing forex accounts of the overseas Indian community. Raghuram Rajan, as governor of the RBI, ended it in 2013. The RBI set up a swap, asking banks to open forex deposits and guaranteeing that the central bank would bear the currency risk . This built a war chest.
As of now, the RBI has foreign exchange reserves of $ 415 billion. This is good for about 10-11 months of imports and accounts for about 18% of GDP. On the surface, comfortable. However, the cumulative exposure of India to the REIT is about $ 190 billion. This money could, in theory, disappear very quickly.
There are also multiple external debt commitments, with a total external debt standing at $ 529 billion by the end of March 2018. About 42%, or about $ 222 billion, mature in the next 12 months – and that's over 50% of the reserves. Since these loans must be maintained, the reserves are not as important as they seem at first glance. India's reserves went from $ 423 billion on April 20 to $ 415 billion on May 18. The $ 8 billion decline was caused, at least partially, by the sale of RBI on the market to support the rupee. In 1997, Thailand, then an economy of about 180 billion dollars, blew up its reserves by 40 billion dollars (more than 22% of GDP), defending unsuccessfully the baht. The Thai economy has contracted about $ 120 billion when the baht collapsed. It's a telling tale about what can happen if policymakers panic.
The conventional way to defend a currency is to raise interest rates and increase returns. Of course, higher rates also slow down economic activity. But given the weakness of the currency and the rise in inflation, it may be necessary to raise interest rates. Indeed, his latest monetary policy review indicated that the RBI will raise rates.
In the long term, improve economic efficiency – facilitate business by cutting red tape, creating better infrastructure and simplifying tax systems, maintaining law and order – and speeding up the rate of growth is the best way to defend.
Of course, there are short-term elections.
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