Global Investing

Good reasons for rupee’s fall but also for recovery

November 22, 2011

It’s been a pretty miserable 2011 for India and Tuesday’s collapse of the rupee to record lows beyond 52 per dollar will probably make things worse. Foreigners, facing a fast-falling currency, have pulled out $500 million from the stock market in just the last five trading sessions.   That means net inflows this year are less than $300 million, raising concerns that India will have trouble financing its current account gap.  The weaker currency also bodes ill for the country’s stubbornly high inflation.

Why is the rupee suffering so much? First of all, it is a casualty of the general exodus from emerging markets. As a deficit economy, India is bound to suffer more than say Brazil, Korea or Malaysia.  And 18 months of interest rate rises have taken a toll on growth.

UBS analysts  proffer another explanation. They point out a steady deterioration in India’s net reserve coverage since the 2008 crisis. The reserve buffer — foreign-exchange reserves plus the annual current account balance, minus short-term external debt — stands at 9 percent of GDP, down from 14 percent in 2008.  Within emerging markets, only Egypt, Venezuela and Belarus saw bigger declines in net reserve coverage than India.

“What it really means for the present, in our view, is that the rupee is now joining the ranks of higher beta “risk” currencies,” UBS said.

Still not everyone is overly perturbed. Some expect the rupee to rebound as the global picture improves. One reason is that the rupee is generally seen as undervalued in nominal terms, as well as on purchasing power parity (PPP) basis, more so than most emerging currencies. The latter is the rate at which one currency would convert to another to buy the same amount of goods and services in each country. On that basis the Indian rupee would equate to 20 to the dollar, data from the World Bank/IMF shows.  Given the strong underlying story, investors are more likely to buy back the rupee than say the South African rand when risk appetite improves.

Furthermore, Indian equity valuations are looking more reasonable than before, despite the slowing economy. Stocks trade now around 12 times forward earnings, compared to 17 times a year ago. That should lure some overseas cash once the dust starts to settle.

“This may not be bottom of the market but for us, investing at these levels of currency and equity valuations is an attractive proposition,” says Phil Poole, head of global and macro strategy at HSBC Global Asset Management.

Even UBS suggests that the rupee’s slide is evoking “too much melodrama.” The rupee’s fall to 52 had been predicted by them, they said, adding: “Now that it’s there, perhaps you should be turning your attention to buying opportunities.”

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