The equity markets have held up well after the downgrade of nine euro nations; commentators say the fragile finances were no state secret. Perhaps, but the fact that these countries may now want to recall some of the $150 billion or so that they have invested in India would have ramifications for the rupee.
Indeed, the deleveraging in the developed world will weigh on forex inflows and currencies across Asia. Even before that, a weaker euro, which last week tumbled to a 17-month low against the dollar, means the rupee could lose some ground.
In fact, the Reserve Bank of India (RBI) has said that the depreciation of the rupee is the consequence of heightened risk aversion and, of course, home-grown problems such as the capital account. Risk aversion is unlikely to come down in the near term even if it doesn?t go up significantly, which would mean the dollar is likely to remain strong. Moreover, together with the other euro countries, Germany too seems to be slowing down?GDP for the December 2011 quarter contracted by about 0.25%, suggesting that the euro zone?s strongest economy may see a mild recession. So now there?s the additional worry about India?s exports to the euro zone not growing on expected lines and pressuring the trade deficit; overall exports grew at a very anaemic 6.7% in December to $25 billion.
Of course, the RBI has initiated moves to make it attractive for non-resident Indians to park their savings in the country by freeing interest rates on NRE accounts for instance. But then corporates will also be repaying or refinancing an estimated 88 billion in foreign currency loans in 2011-12, the bulk of which ($58.5 billion) is trade credit. Rolling over trade credit is not going be easy while getting fresh trade credit too will be a challenge. While bigger companies should not have trouble accessing money, they will have to pay even more now given that the cost of funds in overseas will go up. What can provide a cushion for the rupee is capital flows into the equity markets and the initial trends in 2012 are reassuring ; after consistent outflows in 2011, emerging market equity funds saw inflows of as much as $1.88 billion in the week to January 11. China has seen around $500 million move in while India has got around $100 million; in both markets, the bulk of the funds has come through ETFs. Whether the flows will sustain though is a big question; already on Monday, the MSCI Emerging Markets Index gave up 0.6% while the Shanghai Composite Index dropped 1.4% with investors apprehensive that the Chinese economy may have grown at the slowest pace in 10 quarters. Slower economic growth and weaker than anticipated corporate earnings could prove to be India?s undoing too; so far things haven?t gone too well this earnings season with the management at Infosys cautious about the near term. HDFC?s numbers, however, indicated that consumer demand appears to be holding up pretty well.
Much would depend on how soon the interest rate cycle turns. Although headline inflation may have come off to 7.4% in December, the concern is that inflation in manufactured goods remains high at 7.4%, up 0.5% m-o-m, partly due to depreciation in the currency. Lower prices of commodities could help especially lower crude oil prices but there?s no sign of that yet.