RUPEE COME INTO VIEW

The INR has depreciated sharply and touched an all-time low in June. The stress was primarily due to renewed concerns over tapering of QE 3 and resultant reduction in capital flow leaving the INR vulnerable to depreciation pressures. The deterioration in the trade balance for May 2013 that was driven by a surge in the volume of gold imports added to the downward slide of the rupee. One aspect emerging clearly now is that the main support for emerging market assets since 2009 easy US monetary policy is likely to diminish going into financial year 2014. Developing economies such as India that are dependent on volatile capital inflows to fund its current account deficit are going to be most vulnerable to the conditional event unfolding later in the year. This stress on currency side could also filter into the credit market through external loans into developing countries such as India. In fact, Credit Default Swap spreads for Indian companies have already risen by 80-90 basis points (a basis point is 0.01 percent) over. The realization has made Reserve Bank of India revise its provisioning norms for loans to corporates with unhedged foreign currency exposure. The expectation of policy rate cut has been premised on subdued growth prospects and a decline in both wholesale and retail levels of inflation. Macro data released so far continues to support further policy easing by the Reserve Bank of India. Grim prospects of rupee and Current Account Deficit funding has created a sticky situation for Reserve Bank of India. This is because the sell-off in the INR is likely to have some inflationary impact in the near term even after adjusting for subdued global commodity prices and weak corporate pricing power. Further while capital inflows into the country are known to be more sensitive to earnings (equity markets) than to interest rates, the pressure on the INR recently has been driven by debt market outflows and it would not be prudent for the Reserve Bank of India to undermine the prevailing interest rate arbitrage with the advanced economies by pressing ahead with a policy cut at this stage. In the Indian context, equities have yo-yoed and long bonds could run into a Reserve Bank of India on pause mode as far as key interest rates go, as the current account deficit, its funding and INR trends limit the room for meaningful cuts near term. Gold has had its worst quarter in more than four decades, but there are divergent views on whether the bull market is over. Elections add an India-specific uncertainty. Source: The Wise Investor, Vol. 7 Issue 2, July 2013