THE AGING RUPEE 28th Nov’11

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The Rupee at 50 seemed to be a distant possibility not too long ago. Believe it or not, today rupee is hovering around 52 against the US dollar. First, the deteriorating external environment drove investors to the US dollar as a flight to safety, hitting almost all the Asian currencies. The depreciation in rupee accentuated when the weakening domestic environment in the form of widening current account deficit, coupled with a rising fiscal deficit came to the fore. In the wake of an impending global slowdown and weak fundamentals at home, nothing augurs well for the rupee in the months ahead.

This analytical piece is an endeavor to compile a mix of external and internal factors, which we believe would continue to push the Indian rupee northward to around the 54.00-55.00 levels in FY12.

Twin Deficits Worrisome: A widening current account deficit and higher fiscal deficit (known as twin deficits) have raised serious macroeconomic concerns for India. These can be attributed as one of the underlying for the sharp fall in the Indian rupee. Though the government is still eyeing the targeted fiscal deficit of 4.6 for FY12, it looks over ambitious, considering the shrinking tax revenues and lesser proceeds from the disinvestment process. It looks very likely that the fiscal deficit for FY12 would hit the psychological mark of 5 percent of GDP. On the trade front, the dwindling consumption in the developed world has already started showing slippages in India’s exports. The latest numbers show that India’s exports fell to a 12-month low of $19.9 billion in October, pushing the trade deficit to a four-year high of $19.6 billion. As a result, the current account deficit for FY12 may breach 3 percent of GDP against the estimated 2.6 percent of GDP. In view of the emerging global headwinds, Balance of Payment (BOP) would continue to remain under pressure for the remaining part of FY12, translating into a persistent weakness in the rupee.

Source: Bloomberg, Finance Ministry of India

Currency USDINR Strategy BUY Range 51-51.50 Target -1 54.00 Target -2 55.00

Research Vikash Bairoliya +91 22 3296 8165 vikash.bairoliya@nirmalbang.com Subhash Lalwani +91 22 3296 8171 subhash.lalwani@nirmalbang.com

FY12

Government Estimate

Likely

Budgeted Fiscal deficit

4.6%

5.0%

Budgeted Current deficit

2.6%

3.0% -30000

-20000-10000

01000020000300004000050000

M-o-M Trade Numbers of India

EXPORT IMPORT TRADE DEFICIT

THE AGING RUPEE 28th Nov’11

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100.00

105.00

110.00

115.00

120.00

Reer (6-Currency Trade Based Weights) (Base 2004-05)

RBI Intervention - A Limited Option: RBI has time and again reiterated that its ability to stem the fall in rupee is limited considering the fact that this fall is driven largely by external factors where RBI has little or no control. Moreover, the RBI looks unwilling to taper off foreign exchange reserves especially when India’s BoP is facing a challenge on account of global and domestic headwinds. However, we do not rule out small interventions from time to time which we believe would help more to control the pace of the rupee depreciation instead of lending any significant strength to the rupee. Change in Stance of RBI: Considering that inflation has remained persistently much above the comfort zone of the Reserve Bank of India for almost two years, the central bank persevered with its anti-inflationary stance during the current year. However, RBI gave due consideration to growth risks in the last policy review meet, reflecting the moderating growth concerns. The policy stance has been calibrated broadly in the context of inflation-growth dynamics with more emphasis on containing inflation. Now with signs of moderation in demand and RBI’s projections of a decline in inflation and inflationary expectations from December, the tone of RBI could turn a little dovish from here on which would not correspond with a stronger rupee.

Real Effective Exchange Rate (REER): REER measures a domestic currency’s competitiveness against other major currencies and is an indicator of its relative value versus foreign currencies after adjusted for inflation.

Though a lot has been talked about the sharp depreciation in the rupee, the intrinsic value indicates that the rupee looks fairly valued. The 6-currency REER stood at 108.75 at the end of October, showing that the rupee was over-valued to an extent of 8 percent against the six major trade-weighted currencies. However, the rupee has fallen by another 6-7 percent from October-end, which would have brought the rupee at just about fair valuations. So this gives cushion to RBI to not be overly worried about the depreciation of the rupee and retain its non-interventionist approach.

Source: RBI, NB Research

Expensive & Tight Supply Of ECB: Many corporates knocked the window of External Commercial Borrowing after the rate hikes by RBI surged the cost of capital in domestic markets. However, on the back of surging LIBOR rate (International dollar-funding rate), external commercial borrowing window also seems to have narrowed of late, capping the dollar inflows further. Looking at the dollar crunch in the global markets, the dollar funding rate is likely to remain elevated. Against this backdrop, coupled with lesser risk appetite of Western banks to lend to emerging markets in the prevalent uncertain environment, India Inc is less likely to raise funds through the ECB route in the coming days, despite the Reserve Bank of India (RBI) relaxing overseas borrowing norms. Moreover, low investment sentiment with the falling rupee is not too conducive for corporates to tap the ECB route, which could take a toll on the demand for ECBs.

THE AGING RUPEE 28th Nov’11

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Source: RBI, Reuters, NB Research

Demand-Supply Dynamics: The dollar demand has clearly outpaced supply since early August this year. Henceforth, we believe that this equation will continue to remain in play for the rest of FY12. On one hand, dollar supply is very less likely to be robust, taking the subdued inflows, drying exports, fragile external environment and falling external commercial borrowing in to account, and on the other, the dollar will find strong bid on the back of higher oil and gold import bills. Moreover, with no significant solution to the euro zone debt crisis in sight, global uncertainties are most likely to keep investors interested in the US dollar in the coming months.

Recommendation: The rupee may show some strength at the current levels which could be termed as a ‘Sentimental Pullback’ against the steps taken by the government to relax ECB norms and enhance FII limits in government and corporate debt securities. We believe the level of 51 is a good level to go long in USDINR pair for a target of 54.00-55.00 by the end of FY12.

00.5

11.5

22.5

33.5

44.5

Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11

In b

illio

n do

llar

ECB/FCCB Inflows in India

00.10.20.30.40.50.6

1/6/

2011

10/6

/201

121

/06/

2011

30/0

6/20

1111

/7/2

011

20/0

7/20

1129

/07/

2011

9/8/

2011

18/0

8/20

1130

/08/

2011

8/9/

2011

19/0

9/20

1128

/09/

2011

7/10

/201

118

/10/

2011

27/1

0/20

117/

11/2

011

16/1

1/20

11

LIBOR (3 Month)

Disclaimer: This Document has been prepared by N.B. Commodity Research (A Division of Nirmal Bang Commodities Pvt Ltd). The information, analysis and estimates contained herein are based on N.B. Commodities Research assessment and have been obtained from sources believed to be reliable. This document is meant for the use of the intended recipient only. This document, at best, represents N.B. Commodities Research opinion and is meant for general information only. N.B. Commodities Research, its directors, officers or employees shall not in any way be responsible for the contents stated herein. N.B. Commodities Research expressly disclaims any and all liabilities that may arise from information, errors or omissions in this connection. This document is not to be considered as an offer to sell or a solicitation to buy any securities. N.B. Commodities Research, its affiliates and their employees may from time to time hold positions in securities referred to herein. N.B. Commodities Research or its affiliates may from time to time solicit from or perform investment banking or other services for any company mentioned in this document.