Indian rupee claws back lost ground, appreciates over 3% at 64.70

Indian rupee has regained much of the ground it lost over the month of August and part of September. Since the trough of 66.86, it has now appreciated by over 3% towards 64.70 on spot. A number of factors have their part in ensuring that the rupee continues to appreciate against most currencies. The emerging market baskets of currencies have had a fantastic two weeks, appreciating significantly and that has fed into the rally in the rupee. At the same time, RBI’s decision to hike FII debt limit is also making the currency significantly stronger. Global financial markets are in a ‘risk on’ mode. Indian bonds and equity markets too have had a sizable rally over the past few days.

We view the recent bounce as an interplay of US Fed’s dovish realignment and feedback of rebound in commodities into the larger EM space. However, though financial markets have got their mojo back, but economic situation continues to disappoint. But it would be foolhardy in an age of central bank omnipotence to argue about valuations and trajectory of financial assets just on the basis of macro and micro fundamentals. A more nuanced approach would be sentiment and expectation of fresh liquidity. Sentiments had become more extreme a few weeks back when global financial assets had a sudden  move on the downside. Since then, sentiments have moderated and as the appreciation in risk assets progress, we could see the pendulum swing towards greed zone.

Sentiments need to become exuberant before the reality of a weakening economy plays its part on the financial assets once more. We should be more concerned about second degree derivatives than first, or in other words, the momentum of growth trajectory and sentiment, than just the absolute levels. Take the case for Indian external trade. India’s merchandise exports fell for the 10th consecutive month in September this year, surpassing the consecutive 9-month drop in 2008-09 global recession. Exports contracted 24.3 per cent, the steepest in 75 months, to $21.84 billion in September, against $28.86 billion in September 2014. Taking a peek inside the exports data we find that refined petroleum products plummeted over 60 per cent, engineering goods nearly 23 per cent and electronic goods over 16 per cent, just six items out of 30 items for exports registered y/y growth in September, against seven in August. Global growth is biting the global export community hard. It should come as no surprise to the readers of this column, as I have written about it extensively over the past so many months. It is elementary, that commodity exporters and China, who together have contributed a disproportionate amount to the global growth since the year 2000, would take the wind out of the sails of the world economy, when they face an epic economic slump. Then street was too busy extrapolating the gains of a commodity and China bust, forgetting to add up the other side of the equation.

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It is not just exports which paint a weak picture, have a look at the non-oil imports data. Non-oil imports in September were at $25.69 billion, 10.68 per cent lower in September 2014. This is attributed to the slow growth in the domestic economy. I would like to add that in September of last year, there was a month on month growth of 7.7% in merchandise exports. Hence, the de-growth data in September of this year has been partly magnified by that base effect. If the exports maintain a similar month over month trajectory then the rate of decay can narrow to 13-16% over the rest of the year. Nevertheless, it does not in anyway dilute the seriousness of the situation. One should not forget that sectors like gems and jewelry, commodities and textiles/ yarns provide significant employment and hence a distress in these sectors can ripple through the domestic job market.

With exports in such a strain, we would expect RBI to continue to prevent the excessive appreciation of the rupee. I agree that currency value might be insignificant in altering the landscape for exporters because it cannot over rule the world economic situation and our limited ability in participating in a FX war. But a strong rupee can add to pain of the exporters and even domestic producers in tradeable sectors. A strong rupee makes imports cheaper and exports dearer, not a desirable thing in the current situation. One should not get carried away in the euphoria in the stock market, because, again, in the age of central bank omnipotence, markets which were supposed to be bell-weather entities for the economy have been impaired to such an extent where one may have the right to question their importance as sign posts. Therefore, over the medium term, we can expect a range of 64.30/64.50 and 66.00, which can expand on the upside, when the risk aversion intensifies.

Anindya Banerjee is an analyst at Kotak Securities