Avinash Vazirani, manager of the Jupiter India Fund says Indian politics, a rudderless central bank and US tapering fears are all playing their part in driving down the Indian rupee. India’s long-term economic growth prospects however should, in his view, continue to reward the patient investor…
Tracking the latest slump in the Indian rupee against the world’s major currencies, we have been struck by how reluctant the Reserve Bank of India (RBI) has been to intervene directly in the markets to support the currency. There was a time when the RBI was much less shy about coming forward. At the height of the financial crisis, in 2008, the central bank had no qualms selling billions of dollars a day to support the rupee and send a message to the markets that there was a level below which it would not accept further depreciation. So what’s changed?
The RBI, in our view, is the victim of unfortunate timing. The outgoing governor of the central bank is in the process of handing over the reins to his successor, Raghuram Rajan. Rajan does not officially take up his post until 5 September, leaving something of a power vacuum at the top of the RBI. In such an “interregnum”, it is quite easy to imagine policy paralysis, with a soon-to-be ex-governor unwilling to sanction, for instance, a major intervention in the foreign exchange markets, and a new governor not yet in a position to be able to do so. Once Rajan is in place, we believe the RBI will act more decisively to stabilise the rupee. Concern, meanwhile that the RBI may not have the financial muscle to intervene appears in our view to be unfounded given the latest data showing a rise in the central bank’s forex reserves.1
The minutes of the latest RBI advisory committee meeting meanwhile provide another clue, in our view, as to why the RBI has been less active in the foreign exchange markets than in the past. The minutes show some members of the committee were keen to let the rupee continue its downward slide as it would improve the competitiveness of India’s exporters.2
While the speed of the rupee’s decline may be causing some investors concern, we believe it is important to view this downward swing in the context of summer trading volumes where smaller, single bets by traders on a currency can have a disproportionate impact in the absence of bigger, key players.
On a more positive note, RBI’s measures to boost the country’s beleaguered banking sector and lower the cost of borrowing do appear to have had some effect. The central bank’s announcement this week that it would buy Rs80bn ($1.2bn) of long-dated government bonds did see the yield on the benchmark 10-year government bond fall back to 8.2% from an intraday high of 9.47% on Tuesday.3
The political climate in the country is also doing little to boost positive sentiment towards India. The current government is much too focused, in our view, on legislation that will help it to get re-elected, with the country due to go to the polls by the middle of next year at the latest. Some of the more difficult structural reforms that need to be undertaken have been put to one side. Apparent disagreement meanwhile between the government and the outgoing Governor of the RBI, Duwuri Subbarao, over macro-economic policy has done little to boost confidence that there is a clear economic and monetary strategy in place to take the country forward.4 It is our view that India would benefit hugely if early elections were called if only to end this period of uncertainty dominated by political electioneering.
Domestic politics may be playing its part in the rupee’s slide but US monetary policy is also having a significant impact. The US Federal Reserve’s $85bn-a-month bond buying programme unleashed a wave of cheap money that found its way into emerging markets where it could earn higher yields than in developed markets. Since the US Federal Reserve has signalled it would be cutting back on its bond buying once the US economic recovery is on sure footing, investors have been piling out emerging markets, sending these countries’ currencies spiralling down. In various degrees, Brazil’s real, Indonesia’s rupiah or Mexico’s peso, just like the Indian rupee have all fallen sharply against the US dollar. With the Federal Reserve still unwilling to set a date on when it will start the tapering of its quantitative easing programme, as its bond buying scheme is better known, the rupee and other emerging market currencies are likely to remain volatile.
That said, economists do see the rupee strengthening against the US dollar by year end and it is a view we share. It is easy in the current currency maelstrom to forget some of the key strength of the Indian economy. First, it is an economy that it is still growing at a solid pace with the IMF forecasting GDP growth of 5.6% in 2013 and 6.4% in 2014.5
Even if the growth rate is marginally lower than this, much of this growth will be driven by the huge amount of demand for goods and services from India’s growing population of 1.2bn. And whilst a falling rupee does raise the spectre of inflation, India’s exporters will be rejoicing. It will be up to the RBI to steer a delicate course between growth protection and currency stabilisation.
We continue to remain overweight consumers as we believe that this is the most resilient sector in India with good growth, particularly in view of expected higher agricultural output and the resulting rural growth (70% of the population still lives in rural India) and have increased exposure to exporters who will benefit from a competitive currency.
1 Reuters 16.08.13
2 FT 22.08.13
3 FT 21.08.13
4 The Times of India 18.08.13
5 IMF Website – Country forecasts