ECONOMETER

Sentiment for the Indian rupee (INR) has gone from bad to worse. A number of concerns have hit the currency including weak economic data, deteriorating confidence in government policies, and intensifying risk aversion. The latest blow to the rupee came from data showing that economic growth in Q1 2012 slowed to 5.3% the slowest pace of growth in nine years. Worryingly high interest rates in the wake of persistent inflation pressures have damaged investment spending, a major weak point in the Q1 data. High inflation at over 7% means that the Reserve Bank of India has limited room to ease policy but the central bank has hinted at lower rates in the wake of lower oil prices.

These economic pressures have come at a time when the global environment has worsened. India was already more vulnerable compared to its Asian neighbours due it’s twin current account and fiscal deficits. Strong growth had put concerns about these deficits on the backburner but with growth slowing it only exposes India’s fragility. While less exposed to a global trade slowdown compared to other countries in the region India nonetheless is highly exposed to financial contagion. The INR is a high beta currency, sensitive to the vagaries of risk. The rise in risk aversion over recent weeks left the currency highly vulnerable as its sharp decline attests to.

Despite a host of regulation changes from the authorities the INR has continued to fall, with no let up in sight. While the RBI has suggested that it could sell USDs to oil companies to stem the decline in the rupee it may only result in slowing INR declines in the current environment. It’s decline against the USD has surpassed other Asian currencies. Interestingly there has not been a major exodus of portfolio capital from India, surprising given that other Asian countries such as Korea and Taiwan have seen significant outflows of equity capital. Nonetheless an escalation in the Euro crisis could quite easily change the picture for the worse.

It is not all bad news for the INR. While it will remain under pressure for some time yet from a valuation perspective the INR is looking increasingly cheap. I wouldn’t run out and buy it just yet but I would argue that a lot of bad news is already priced in to the currency. Investors will need to see some better news both externally and domestically and unfortunately this is lacking, but should risk appetite began to turn around the potential for rupee appreciation is significant for a currency that has lost close to around 20% of its value over the last 12 months. In the meantime, the best that could be hoped for is a slowing in the pace of depreciation, with a fall to around 57-58 versus USD on the cards over coming weeks.