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.
And here almost 6 months down the line how right you were! INR against USD almost 60 Rs!
By: Amit on June 26, 2013
at 5:35 pm