Indian rupee is an inter-play of global risk sentiments and domestic factors.
Indian rupee is an inter-play of global risk sentiments and domestic factors. Vote for Brexit is a momentous event in history. It has the capacity to raise questions about the irreversibility of the European Project.
The implications of such an event is going to be felt over a very long period of time, as we can see various anti-EU forces congregate and seek similar referendums in countries like France, Netherlands, Greece, Portugal, Italy and Spain. Therefore, though coordinated actions of central banks and G7 authorities may act as a fire-break for financial markets, but we would caution against taking such an event lightly. Thanks to central banks involvement with un-orthodox monetary policies, we have seen risk assets around the globe float higher inspite of weak global macros. The significant speculative premium in risk assets can be at the risk of deflating if the intended and unintended consequences of the Brexit become too adverse.
For India, though domestic macros are relatively stable but we should not become too complacent about risks flowing to India. Remember, in 2008, Indian economy had one of the best macro positioning and yet its currency depreciated by nearly 33 per cent due to risks flowing from abroad. We continue to see Yuan overvaluation and its economic vulnerabilities as the biggest risk for the Indian rupee over the near future. With Europe in a political and possible economic turmoil, one of the biggest market for Chinese and Indian goods and services, there can be risk of a depreciation in the currencies of India and China. Chinese authorities need to safeguard the financial system against a debt default shock. The leverage ratios in China is at very high levels and in such a situation, China needs to adopt an ultra-loose monetary policy, which would cause Yuan to depreciate rapidly. The catalyst for such an event could be the turmoil in Europe. If Yuan were to fall it is most likely to take the rupee down with it.
Rupee is also exposed through the large amount of FII investments in India. Investment through emerging market ETFs has become a major vehicle for investing in India. During times of global macro stress, these ETF investments can head for the exit door and that can have negative consequences for Indian stocks and bonds and hence the Indian rupee. Add to the uncertainty which Indian exporters and Indian companies with operations in UK would face.
All in all, Indian rupee could see more depreciation and levels of 67-69 remains in near term.
The author is currency analyst, Kotak Securities.