INR – Risk scenarios
„USD/INR records steepest year-to-date fall in 20yrs
INR weakness accelerated today with spot reaching a historical high of 68.755
intraday, a fall of 2.75%. In ytd terms, this represents a fall of 19.3% - the
steepest fall since the balance-of-payments crisis in 1991. This begs two key
questions: First, what is driving this dynamic and second, what are the risks.
Three dysfunctional dynamics
#1 Oil and commodity prices – Geopolitical concerns over military intervention
in Syria are prompting oil prices to break higher. Additionally, gold prices are
gaining on safe-haven buying. As such, the RBI’s calculated oil basket and gold
prices in INR terms are at record highs (chart 1). This price effect is hurting the
government’s efforts to repress gold imports and narrow the current account
deficit. That said our own conversations with onshore market participants did not
see panic USD buying by oil importers in the onshore FX market today.
#2 Fiscal concerns - The overnight passage of the Food Security Bill (INR1.35tn)
and the infrastructure projects (INR1.8tn), by the Indian parliament triggered fresh
fears that this will be the beginning of a spending spree and erosion of credibility.
#3 Policy vacuum – An additional contributory factor is the absence of direct FX
policy action. Moreover, the overnight policy statement that a panel would be set
up to investigate the expansion of bilateral central bank FX swap lines over the
next month was interpreted more as policy inaction. India entered a USD15bn
swap arrangement with Japan in 2011 to improve access to crisis USD funding.
Three policy risk scenarios
Status quo remains: INR depreciates and we have to wait for the current
account to correct and assume less FII inflows under Fed QE tapering. A
conservative estimate is USD/INR goes to 70 year-end and 75 by-end 2014
based on NDF forward pricing.
#1 Very likely policy action – NRI (Non- resident Indian) bond issue. We
stabilize USD/INR at current levels, but stay in elevated trading range USD/INR
63-69.
#2 Likely policy action – hike rates. Failure to attract capital inflows amid Fed
tapering and 2014 India election uncertainty runs the risk of a crisis of confidence.
This would likely accelerate INR weakness to 75 by year-end and induce
emergency rate hikes, but cause an earlier stabilization and recovery in USD/INR
back to 65-70 levels by mid-2014.
#3 Unlikely – capital controls: This goes against India’s FX legislation and will
deter the future inflows required to fund the existing current account deficit.
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„USD/INR records steepest year-to-date fall in 20yrs
INR weakness accelerated today with spot reaching a historical high of 68.755
intraday, a fall of 2.75%. In ytd terms, this represents a fall of 19.3% - the
steepest fall since the balance-of-payments crisis in 1991. This begs two key
questions: First, what is driving this dynamic and second, what are the risks.
Three dysfunctional dynamics
#1 Oil and commodity prices – Geopolitical concerns over military intervention
in Syria are prompting oil prices to break higher. Additionally, gold prices are
gaining on safe-haven buying. As such, the RBI’s calculated oil basket and gold
prices in INR terms are at record highs (chart 1). This price effect is hurting the
government’s efforts to repress gold imports and narrow the current account
deficit. That said our own conversations with onshore market participants did not
see panic USD buying by oil importers in the onshore FX market today.
#2 Fiscal concerns - The overnight passage of the Food Security Bill (INR1.35tn)
and the infrastructure projects (INR1.8tn), by the Indian parliament triggered fresh
fears that this will be the beginning of a spending spree and erosion of credibility.
#3 Policy vacuum – An additional contributory factor is the absence of direct FX
policy action. Moreover, the overnight policy statement that a panel would be set
up to investigate the expansion of bilateral central bank FX swap lines over the
next month was interpreted more as policy inaction. India entered a USD15bn
swap arrangement with Japan in 2011 to improve access to crisis USD funding.
Three policy risk scenarios
Status quo remains: INR depreciates and we have to wait for the current
account to correct and assume less FII inflows under Fed QE tapering. A
conservative estimate is USD/INR goes to 70 year-end and 75 by-end 2014
based on NDF forward pricing.
#1 Very likely policy action – NRI (Non- resident Indian) bond issue. We
stabilize USD/INR at current levels, but stay in elevated trading range USD/INR
63-69.
#2 Likely policy action – hike rates. Failure to attract capital inflows amid Fed
tapering and 2014 India election uncertainty runs the risk of a crisis of confidence.
This would likely accelerate INR weakness to 75 by year-end and induce
emergency rate hikes, but cause an earlier stabilization and recovery in USD/INR
back to 65-70 levels by mid-2014.
#3 Unlikely – capital controls: This goes against India’s FX legislation and will
deter the future inflows required to fund the existing current account deficit.
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