Rupee to dollar: Risk aversion is positive for the American currency

Updated: Jul 14 2014, 15:42pm hrs
Indian rupeeOver the previous week, we witnessed two shades of the Dollar/Rupee market.
Over the previous week, we witnessed two shades of the Dollar/Rupee market. Going into the Union Budget, the local unit appreciated towards 59.57 levels on spot, but the day the Budget was announced we saw a huge U-turn in the market, as Rupee depreciated towards 60.20 levels. On last Friday, as domestic equity lost some more ground, the pair pushed towards 60.30 levels, but closed the week around 59.93 levels on spot.

Importers and oil marketing companies generally came on the bid in the US Dollar below 59.70/60 levels but FIIs, through their custodian banks, have been to happy to purchase the Rupee below 60.10 handle. At the same time, central bank has become a much active player on the market, intervening on either end of the trend. As a result, volatility has become compressed in USD/INR. In fact, volatility has also reached historical lows in many major currency pairs in the world, thanks to economic interventionist policies of major central banks in the developed world.

India's industrial output in month of May grew at 4.7% v/s 3.4% rise in seen in April and 2.5% fall seen in May of last year. IIP was at the highest levels since October of last year. Manufacturing growth picked up from 2.6% in April to 2.7% in May, lead by 4.5% surge in capital goods output. We are banking on a gradual recovery in the industrial sectors of the economy in the coming quarters.

India's new finance minister tabled his maiden Budget and considering the fact that he has been in office for less than two months, most of the lack of specifics can be given a benefit of doubt. Intent was clear, that fiscal consolidation remains a priority and also capital augmentation is the need of the hour. The new finance minister has announced a slew of schemes, mostly to honour the pre-poll commitments of his political party. There was significant emphasis on the public-private partnership model of development. However, the current structure of PPP framework has been a non-starter and hence we expect an overall in the same. Though the Union Budget was not groundbreaking but it was at least not overly populist. There was a gross acceptance of the accounting window dressing that was done by the previous government. Within the limited fiscal headroom, GOI has tried to offer whatever little tax benefits can be given to individuals and businesses. He has also tried to streamline procedure and remove legislation inconsistencies.

Turning focus on the fiscal numbers: GOI is betting on a tax buoyancy as they forecast a growth of 18% this fiscal, higher than 14% that has been the average growth over the last five years. With a forecasted nominal GDP growth 12.5/13.00% this fiscal, GOI could fall short by 25/30K crore in tax revenues. However, that shortfall can be more or less made up in the disinvestment target of projected 56k crore. Therefore, unless there is a sharp increase in the subsidy burden, GOI might not be too far off from the projected gross fiscal deficit of 4.1%.

Subsidy as % GDP has been projected to decline from 2.2% to 2.0%. Food subsidy now contribute 44% to the overall subsidy of the government, followed by fertiliser at 28% and petroleum at 24%. Total subsidy burden is projected to be at INR 2.6 lakh crore.

Non-plan expenditure has been projected to increase by 9%, lower than 5 year average of 13% but plan expenditure has seen a sharp jump to 21% v/s 5 year average of 12%. Revenue expenditure is projected to rise in line with last 5 year average of 12%, whereas the capital expenditure is projected to increase by 19% instead of 17% seen over the last 5 years.

The revenue deficit is projected to be around 2.9% of GDP lower than 3.3% that it clocked in FY14. Primary deficit, which is fiscal deficit excluding interest payments, is projected to be at 0.8% v/s 1.3% for last fiscal. Net borrowings projected at INR 4.07 lakh crore, lower by 4% over FY14.

Certain regulations were undertaken to plug loopholes in the tax system, like reworking the tax liability on debt mutual funds and also on the profits generated on sale of house property. At the same time, GOI has clarified that gains arising from trading on investment in equity and equity derivatives by FIIs will be now considered as capital gains and not as income from regular business. Going forward, market will keep a close eye on implementation of said policies. India needs to reduce retool and reduce government expenditure and also work towards tax reforms.

Globally, thanks to the "central bank put", risk assets have managed to maintain themselves at elevated levels. The fear is that, significant overdose of monetary medicine, that the major central banks have administered are making financial markets more fragile. A rise in the stress in the Portuguese financial markets, last week, was an ugly reminder of the same. Indian Rupee and our equity and debt markets are significantly dependent on the fortunes of the global economy and its financial markets. Therefore, while building an analysis on the domestic asset, we should pay due attention to global situation. The prospects for global economy appear less sanguine as years of cheap and easy money may have distorted many of economic indicators, which we use to judge the true health of an economy. Additionally, history has taught us that monetary authorities in the past have not been much successful in judging excesses and inflexion points in financial markets and their economies Therefore, we have to remain fleet footed when investing and trading financial markets, including currency. Volatilities or uncertainties are like spring, the longer and harder they are compressed, the greater becomes the probability of an unprecedented recoil in the future.

Over the next week Indian Rupee may continue remain ranged, between 59.50/70 and 60.15/30 levels on spot. Keep an eye on the trend in global financial markets as risk aversion is positive for the US Dollar.

By Anindya Banerjee, Ananlyst, Kotak Securities