Posted by: qmaxim | January 13, 2013

Indian Rupee headed down- may touch 60 to US$

US$ to Indian Rupee (INR)  conversion rate is critical for the Indian economy,  government, export /  import dependant companies, IT sector, foreign &  local investors. Considering the importance,  there is a constant discussion about this in business newspapers, business  TV channels and internet.

Many experts  (mostly fund manager types ) are asked about their views about this   – some of them are of the view that INR will appreciate in short to medium term but others are of the view that INR will remain where it is now (about 55 INR to US$) or even depreciate. On the other hand,  govt.  figures, bankers &  people from  Reserve bank of India generally  refuse to speculate.

I have always  wondered  how one can come to  diametrically opposite conclusions with more or less the same type/amount of information. Of course, it is not an easy thing to predict & most of the experts have been off the mark in the recent past. Anyway,  I thought let me also weigh in about this with access to only publicly available information.

I think Rupee is headed down. Here  is why I think so.

Conversion rate  is dependant mainly on the following – demand/ supply, inflows/ outflows, speculation/ perception, govt. action/views,  unknowable events/ actions.

Demand for Dollars:

India is highly dependent on imports particularly oil & oil derivatives; imports meet 80% of  the  demand. In fact, India is the  4th largest  importer of oil in the world. India is likely to remain dependant on imports in the coming years as domestic production has not taken off.
Price of the oil is expected to remain firm in the coming years.

Demand for power in India is insatiable & most of it is generated by burning Coal. India is one of the largest producers of Coal  in the world  & has large proven  reserves. Surprisingly, large amounts are imported -many of the large upcoming power projects are dependent on coal  imports. Same is the situation for many upcoming Steel plants. Though India has one of the largest Iron reserves, many of the large upcoming steel plants are scouting for Iron ore abroad. Most of the coal & Iron ore projects are stuck for environmental, political, legal & other bottlenecks.

Technology  imports such as  high capacity  power generation equipment,  communication gear, military hardware, cell phones, computers, tablets   have also gone up   in the recent years.

Meanwhile, imports of  even low technology daily consumption items is also taking off greatly. For example, even school exercise books, food items, electric bulbs  are now routinely imported. This is not just in supermarkets – even street vendors now sell Chinese apples.  I was surprised  to read a  newspaper item  that even  the small  Indian flag which children wave about  during national holidays  is imported in many cases. (This  was discovered purely by chance  as the  Ashoka chakra in centre  of the imported  flag had  wrong number of spokes). Recently announced policy of  FDR (foreign direct investment) in  retail is likely to accelerate this trend as the policy has no restriction on imports.

India is the largest consumer / importer of gold  in the world. Though economy was not doing too well    last year there was record import of gold. Indians’ craze for  gold is well known and it is unlikely that this trend will reverse in the near future. Govt. reacted by doubling  duty on gold imports. Govt. has limited  manoeuvrability here as increasing duty   further will give a fillip to gold smugglers.

Due to huge interest differential between borrowing rates in US and in India, many of the large Indian companies prefer borrowing from abroad.

Preferred currency for imports is Dollars. From being a country  obsessed with self reliance in the past  it has become import dependant even for daily consumption goods. Due to this trend,  demand for dollars is likely to remain robust and is only going to  accelerate. Increasing import dependency is mostly due to  lack of coherent policy & determination in developing indigenous capabilities

Now about major sources of Dollars inflows:

Foreign investors such as hedge funds, HNIs &  institutional investors funnelled record amounts  into Indian stocks last year. This has lead to rally  of the BSE (Bombay stock exchange) share index   which touched 2 year high.  However, most of the funds are speculative type of funds. Investments by PE funds other companies have been subdued in the recent months.

Another large source of funds is from people of Indian origin working abroad.  Inflows  tend to go up as the Rupee depreciates &/or bank  interest rate increases. Flow reverses as Rupee appreciates.

Also, of importance is   illegal  to legal (called converting  black to white) currency conversion. Large amounts of unaccounted money earned  through  illegal means moves abroad though illegal channels. It  is widely believed that this money comes back to India through  legal  channels as legitimate  investment. It is speculated  that as much as   5% of the GDP  goes out of  the country this way every year.

Earnings by IT companies, who are large Dollar earners, has  slowed down in the  last couple of years.

Even though  economy slowed down  last year, there was  no deceleration in  imports but exports slowed down significantly. Some of it due to problems in the export markets. However,  domestic issues such as high  interest rates, increasing wages, infrastructural issues, depreciation of  currencies of other countries , high domestic inflation, legal/political issues  have  made the exporters less competitive.  This has lead to record current account deficit.

Due to easy money policy of  US- Federal Reserve ( Fed)  and super low  interest rates huge amount of money is available to US  investors for investment.  Since the  growth of US economy has been sluggish  some of  this money finds  it way into India. Though growth in India has been slowing three years in a row still it is one of the few countries with reasonable prospects for growth.

Other  influencers:

Reserve Bank of India (RBI) has limited ability to interfere to influence   exchange rates. It confines its action to controlling the volatility of exchange rate. However, other events such as action by  US Fed  or  Chinese central bank, re-rating by credit rating agencies &  other unexpected events (of black swan type ) can change exchange rate in  unexpected ways.

Why I think Rupee will depreciate?

There was a  widespread perception of policy paralysis, governance deficit, corruption, crony capitalism in the last couple of years.  There was  little movement in government’s  disinvestment of public sector undertaking also. Most of the share sales  were  made to government owned financial institutions.

The Indian economy has been running high budget deficits and growth has been slowing in the recent years.   Many of the  growth  drivers which have lead to growth boom in the past have faced some problem or another.  Most important perhaps are the  infrastructural  projects  which have slowed down significantly. Ambitious highway building program  is able to meet only one third of the target.  Many projects are stuck due to environmental, administrative, financial, legal tangles. Commissioning of Power plants has slowed down (stopped in some cases) due to environmental clearance, fuel related issues.  Construction of mega Steel / Aluminium plants has gone to a crawl or stopped. Many Iron ore mining / Coal  projects have slowed down / stopped due to the same reasons. Oil/gas  exploration is also at a standstill due policy / administrative issues. Telephony sector is also facing  policy issues. Manufacturing sectors like auto, metal, power generation, construction, have slowed considerably.  These would  have cascading effect on all sectors including service sectors. Employment generation also gets effected a great deal.

On top of this,  govt. has increased spending on so called poverty alleviation  programs. With the national elections due in 2014 funding for  these programs  is likely to increase in the coming months.

Investment flows are  driven as much  by perception and sentiment as by cold analysis of expected returns. In the last few months there has been a flurry of activity by the government which has  lead to change in  sentiment for the better by the investment community. For the reasons mentioned,  next year is  likely to  have even  slower  growth rate, high inflation, record deficits, high interest rates resulting in subdued performance by the corporate sector.

All these are likely to result in  sentiments turning negative  in the coming months.  As the price of shares rise investing in shares become less and less attractive.  As the US economy slowly begins recover next year  it will become more attractive for the international investors to invest in US. All these aspects could  result in slowing down of  Dollar  inflows in the coming months.

As argued by me at the beginning of this post,  demand for foreign currency particularly US$ is likely to remain strong in the coming months and years.

So, while  the  demand for Dollars  is likely to remain strong, US$ inflows are likely to be  subdued. This mismatch is likely to result in  steady depreciation of  Rupee against US$. My thinking is that the  exchange rate could touch 60 INR to a US$ in  the next six months.Of course, this is just  a guess assuming factors mentioned above do not change to a significant degree.


  1. And here almost 6 months down the line how right you were! INR against USD almost 60 Rs!

I will be pleased to hear your views

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