Tuesday, 16 July 2013

The Infamous Gang: CAD, Taper and Rupee slide

From the Desk of Chief Marketing Officer
Sharad Bindal

I was willing to write this blog a month ago but failed for I was enjoying my vacations. By the time I returned, there was already a much hue and cry about CAD and QE3 problems- problems supposed to be the primitive reasons behind rupee fall.

Current Account Deficit:

Let’s first understand CAD (Current Account Deficit) as people usually misinterpret it with trade deficit.
The Current Account and Capital account are two components of Balance of Payments and Current account includes balance of trade(net revenue on exports less payment for exports) and invisibles (net investment income i.e. earnings on foreign investment minus outflow in the form of payment to foreign investors and other cash remittances)

The current account balance is one of two major measures of the nature of a country's foreign trade (the other being the net capital outflow). A current account surplus increases a country's net foreign assets by the corresponding amount, and a current account deficit does the reverse. Both government and private payments are included in the calculation. It is called the current account because goods and services are generally consumed in the current period.

The CAD in India was $ 93bn in 2012, second to US in volume, we can expect a saving from low energy prices to the tune of $ 18-20bn in FY14, India still need around $ 70bn from capital inflows. (Though I do not term it a healthy situation to fill the gap of current deficit from capital receipts). Foreign inflows like FDI and FII’s investments have been funding around $ 50bn for last six years (except 2008).

My Point of Concerns: CAD, GDP Growth and Stubborn Inflation
A few days ago, one of my old industry friend was discussing with me the positive signs of our economy and their so called positive effects on the Equity and Debt market emphasizing primarily on CAD coming down from 4.8% to 3.6% and I really wanted to make him a part of my negative economic indicators but his sheer loyalty towards our economy and positive thinking stopped me from doing so.

As the improvement in trade balance in 4Q was known, the QoQ decline in the CAD as a percentage of GDP was not a surprise. My point of concern is decline in invisibles.

Invisibles declined by 8% YOY in Mar.13, the second consecutive quarter of negative growth.

Worryingly, each major part of the invisibles set showed concerning trends:
1.       Investment Income ( i.e. money sent back by MNc’s plus interest payments on bonds) has stayed near  record high levels around US$5bn/quarter
2.      Income from software services remained barely positive( +1% YoY)
3.      Remittances reported a second consecutive quarter of YoY decline.

While further dissecting the Reasons behind CAD falls, what I found was that interestingly 4Q13 was only the second quarter since 2001 (barring the crisis) when import fell YoY but unfortunately, this was accompanied by a fall in export as well.

For me, India’s vulnerability looks serious: the second highest current account deficit in the world after US funded by short term capital receipts, with reserve accumulation stopped since 2008.

My other point of worry is the over-dependency on short loans in the form of short term credit to India. In the current year $ 165bn will be the amount come up for redemption or refinancing.

One of my greatest concerns towards Growth- inflation puzzle is that while the GDP growth has slowed down from 9% in FY11 to decade low of 5% in FY13, the inflation has just decelerated from 9.5% to 7.5% against the basic theories of economy.

At the peak of the investment boom in 2007, private corporate as well as Government announced around Rs. 5 Trillion of new projects every quarter and now it has come down to a striking figure of Rs. .67 trillion.

It compels me to support the RBI contention and its worry over the pattern of current inflation that the problem is from supply side rather than from demand side.

To add to my worry is that when my central bank will realize it completely that rate cuts will not help in such a case, I am afraid about the future of bond yields!!!!

This is nothing but postponing the D- Day. Rather than taking aggressive measures for strengthening of overall economy, we are just carrying forward the deep impact to some future days.

My View:

I still believe CAD to settle down between 4-4.5% by Mar.2014.

Are we heading to Solvency crisis?

However, though India’s indebtedness is rising, external debt to GDP is not at that level that can cause a solvency crisis (21% of GDP) like some of European countries. Even percentage of foreign currency reserves to external debt (144% of reserves) is higher in the decade but much lower what it used to be in 1990s.
So, from my point of view – the solvency crisis is out of question. (It proves that I do not mention only negative indicators of our economy – allegation I face sometimes)
The Infamous “Taper”:
The Employment report of US dated 5th July 2013 was not at all bad. On the basis of prevailing economic conditions, I think , they would be needing somewhere 250000 jobs a month and at this rate, to achieve the level before the recession, it will take around five years and unfortunately without a clear shot, I fear full recovery might not happen at all.

Monetary policies might do the trick but suddenly rather than becoming more aggressive the Fed has started talking about the infamous “Tapering”

Sometimes, I feel that the talk about “Taper” has done more damage than perhaps the “Taper” itself would have done.

I strongly believe that aggressive monetary measures may finally get the US back to full employment and wish the same as I recall tha last time they were in the same situation what happened was…………..

My View:

Only if I could, I would have recommended a jobless rate threshold of 5.5% instead of 6.5% to Fed.
Anyway, as I believe that the reduction in the bond buying program or “taper” is more of monetary policy measure open for flexibility rather than a strategic move.

I AM OF THE VIEW THAT sooner or later the Fed will realize the current importance of lowering of job threshold rather than bowing in front of conventional monetary governing theories.

I see tapering is out of question in near future……. (Another positive talk from my side!!!!!)

Rupee Slide:
In june.13, the rupee dropped to an all time low of 59.7 per dollar and sliding continuously. A sharper than expected trade deficit ( due to surge in gold imports) triggered the then fall in rupee and the domestic currency further weakened after uncertainly regarding the early pull back of QE3 by US Fed. In June.13 FII pulled out $5.4 bn from Debt market and $1.8 bn from equity market.

Even in the recent past, shocks of smaller magnitude have been sending the rupee into a tailspin. The recent capital flight was in response to a common shock across all the emerging economies. Brazil, Indonesia, Turkey, Korea, Russia, Philippines and South Africa saw their currencies weaken by 5-17 percent. Among these, the South African Rand, Brazilian Real and Russian Rouble depreciated the most as these economies have a high current account deficit and rely heavily on foreign funding.

The increasing vulnerability of India’s external account impairs the rupee’s ability to counter even smaller shocks. With limited intervention from the RBI, the value of the rupee against US dollar is almost entirely influenced by demand and supply conditions.

Have a look on the four episodes of rupee depreciation in the past decade:
1.      Aug.08 to Mar.09: Lehman Crisis- Very Big shock-Low vulnerability
After the Lehman crisis, the rupee registered a sharp fall against the dollar due to net FII outflows of US$6.7bn during Aug.08 to Mar.09. The rupee fell to a new low of 52.1 per dollar from 42 per dollar during this period.
2.      Aug.11 to Dec.11: EU recession- Big Shock- Rising Vulnerability
In Aug.11, the rupee began weakening subsequent to the news of double dip recession in the euro zone. In Dec.11, the rupee fell by nearly 17% YoY and reached a new low of 54.2 per dollar.
3.      April.12 to June.12: Fear of Greek exiting from EU- Anticipated Shock- high Vulnerability
In April.12, the rupee started weakening in response to news of Greece exit from Euro zone. This Uncertainty caused the net FII inflow to fall to US$56 million. Moreover, the fear of a global credit freeze resulted in preponement of dollar purchase by India companies to service huge repayment scheduled during the fiscal. The rupee fell to a new low of 57.2 per dollar in June.12 declining by 25% average YoY.
4.      May.13 to July.13: “Taper Announcement”- small shock though high vulnerability
After the Federal Reserve announced a gradual withdrawal of their bond purchase program (popularly known as QE) in May end 2013. FII’s began pulling out funds from debt markets of most of the emerging markets and caused turbulence in rupee’s movement in spite of the fact that this shock was of much low intensity than the earlier one.

My point is that the rising vulnerability of India’s external account is influencing currency exchange rates to the extent that speculations (or we can say smaller shocks) have become a bigger trigger than a dramatic change in the fundamentals itself.

My View:
I believe this depression to be a very short lived situation and expect the currency to come up at a level of Rs. 55 per dollar by Mar.14 though volatility will still be an inherent feature.

At Last: by the time I have ended writing this blog, RBI has already taken the aggressive measure to control rupee slide and thus, I will try to deliver my next blog on the same very soon.