Rupee Through 60 -- Assessing the economic implications ::Credit Suisse

● For the first time ever the Indian Rupee has broken through 60
against the US Dollar. Given the decades-long trend depreciation
of the INR this was, in a sense, only a matter of time.
Nevertheless, the fact that the currency has dropped more than
10% in the last couple of months, while some are talking about an
imminent BOP crisis warrants attention.
● We estimate that if the rupee were to stabilise at the current level,
WPI inflation will be boosted by ½-¾ pp. This takes account of the
softening in USD-denominated commodity prices to date and
reinforces the view that the headline rate will bottom in September.
At the same time, the initial effects of the depreciation will be to
make the trade position worse, with beneficial volume effects of the
weaker currency taking 12–18 months to come through.
● Recent developments mean the chance of the RBI cutting at 30
July meeting are close to zero and indeed if the rupee continues
to plunge rate hikes will come onto the agenda.
● Finally, talk of a repeat of the 1991 BOP crisis are premature.
High fx reserves do at least buy the country plenty of time.

�� -->

After a period of relative stability from mid-2012, the Indian rupee
began to lurch higher (depreciate) against the US dollar from early
May. Since then it has lost more than 11% of its value. As Figure 1
shows, such moves are by no means unprecedented for a currency
which has trend-depreciated for decades, but are worthy of
investigation.
Our purpose here is not to discuss where the currency will go next
(that’s the job of our fx strategists which, for the record, are currently
looking for a level of 61.5 in 3 months and 62 this time next year), but
rather to think about some of the potential economic and policy
implications of the move to date.
1. Inflation: On the basis of our regression model, we estimate that a
sustained 10% rupee depreciation, adds roughly 1 pp to headline
wholesale price inflation over the space of the following 12 months,
assuming everything else is equal. In practice, however, everything
else is not equal as dollar-denominated commodity prices, particularly
metals, have been falling. Taking this into account, we are probably
looking at a ½-¾ pp addition. Even so, we are confident that the
headline WPI rate can fall at least as low as 4% by September before
turning higher. We are also retaining our recent 4.8% and 6.5% fiscal
year average WPI inflation forecasts for 2013/14 and 2014/15
respectively, which compare with June consensus figures of 5.7% and
5.8%. Meanwhile, consumer price developments will continue to
depend largely on food prices and hence the course of the monsoon.
Recent flooding has apparently led some fruit and vegetable prices to
soar, but this should be a short-term effect. The longer-term
prognosis is much better at this stage.
2. External accounts: Our statistical work suggests that the initial
effects of a weaker rupee is to boost import values and cut exports—
not exactly what one would want to see right now. Beneficial volume
effects do eventually dominate but it takes around 18 months for the
full impact to be felt. Against this background and with gold demand
apparently waning, overseas demand likely to remain soft and Indian
domestic demand set to pick up (India capex: The revival
begins) attempting to forecast the current account deficit, and hence,
India’s external funding needs is not exactly easy. The March quarter
current account deficit of USD18.1bn (3.6% of GDP) was in line with
our forecast and below the consensus but the June quarter will be
much worse and the risks to our brave USD73bn (3.8% of GDP)
projection for 2013/14 are, not surprisingly, on the upside.
3. Policy interest rates: The depreciation of the rupee means the
chance of the RBI cutting interest rates at its next meeting on 30 July
is virtually zero and indeed there is probably a higher risk of hikes not
cuts right now given Subbarao’s hawkish nature. For risk to turn to
reality, is likely to require the rupee to continue depreciating (perhaps
to 65), while the central bank may also opt to undertake some
unsterilised fx intervention, pushing market interest rates higher, first.
We still have two 25bp repo rate cuts in the profile but have pushed
them out to the final 3-4 months of the calendar year by which time a
new Governor will be in place. It goes without saying, that this is not
exactly a high conviction call.
Heading into a BOP crisis?
Some have suggested that India is heading into a balance of
payments crisis of the sort it faced in 1991. It seems to us that for this
to materialise would necessitate a prolonged period of global “risk-off”,
a series of very poor real economy and inflation data in India (of the
sort we don’t anticipate) and for the policy authorities not to take
meaningful preventative measures.
The country’s fx reserves (which cover around six months of imports
and are nearly three times the size of short term external debt) also
buys the country plenty of time. Let’s hope it doesn’t need it!