currency
TRANSCRIPT
Macro Research
www.indiaratings.co.in 9 January 2015
Currency
Conundrum of Indian Rupee Strength of US Dollar and RBI Intervention Responsible for Weak Rupee
Special Report
Rupee Movement Not in Sync with Macro Fundamentals: The movement of rupee-dollar
exchange rate is not in sync with economic fundamentals, says India Ratings & Research (Ind-
Ra). Indian economy, although not out of woods, has improved from mid-FY14. While the fiscal
deficit exceeds FY08’s, the twin deficits are no longer a macroeconomic vulnerability. The
outlook for medium-term growth, inflation, current account deficit (CAD) and interest rate has
improved. All these factors could otherwise have led to a strong/stable currency.
Strengthening US Dollar: The strong appreciation of the US dollar (USD; measured by US
dollar Index) is mainly responsible for the weakening of the Indian rupee (INR). Broad US dollar
index (BUSDI) appreciated 7.4% between January-December 2014. BUSDI for December
2014 (110.4) is at 69 months high. USD has been gaining strength against other currencies
due to i) robust recovery in the US economy, ii) withdrawal of quantitative easing (QE) by the
US Fed and iii) continuation of the easy monetary policy followed elsewhere including Japan
and euro zone.
INR a Better Performing Currency: Between January-August 2013, the Indian rupee was the
worst performing currency, by depreciating 21.4% against USD. However, INR was one of the
best performing currencies between January-December 2014. While INR depreciated 3.3%
during this period against USD, the currencies of other major countries such as Australia,
Brazil, Canada, euro zone, Japan, Malaysia, Russia, Sweden, Switzerland and United Kingdom
depreciated more than INR against USD. The euro has been trading at its lowest level (on 7
January 2015) against USD since January 2006 on the expectation of a stimulus from the
European Central Bank to pull the euro zone out of deflation and spur economic growth.
Reserve Bank of India’s (RBI) Intervention: India follows a managed float exchange rate
policy. RBI’s stated policy of intervention in the currency market is to check the unusual
fluctuations in INR. However, the regulator’s intervention lately suggest otherwise. INR
depreciated from INR60.05/USD (monthly average) in July 2014 to INR62.74/USD in
December 2014. This happened despite a strong net foreign institutional inflow of USD21.7bn
during the same period. As per the latest data available, RBI bought USD19.4bn till the end-
October 2014.
Focus on Real Effective Exchange Rate (REER): Although there are many factors that
impact exports, the value of currency is an important factor that determines the export
competitiveness of a country. RBI’s intervention in the currency market lately suggests that it is
trying to keep the value of INR in a particular band based on REER. The fair value of rupee has
been estimated in the range of INR61-62/USD based on REER. However, REER (36-currency
bilateral trade weighted) suggests that the rupee was still overvalued by close to 10% in
November 2014.
Analysts
Devendra Kumar Pant +91 111 4356 7251 [email protected] Sunil Kumar Sinha +91 11 4356 7255 [email protected] Apurva Yadav
Macro Research
Conundrum of Indian Rupee
January 2015 2
Backdrop
Post the 2008 global financial crisis, there have been several instances of INR weakening
suddenly against USD. While the mere mention of unwinding of QE by the US Fed played
havoc with the rupee in mid-2013, this time the rupee remained relatively stable even after the
announcement of QE unwinding in October 2014. INR depreciated 8.4% by end-December
2014 on a point-to-point basis from its highest value of INR58.43/USD on 19 May 2014.
Although the CAD has widened lately due to a higher trade deficit, a higher inflow through the
capital account has provided some cushion. As a result, the country added USD15.5bn to the
forex till the week ended 26 December 2014 (USD12.2bn in FY14). Yet the rupee instead of
strengthening has weakened, and was trading in the band of 61.9-63.7/USD during December
2014.
Figure 1
Before examining the current episode, a brief look at the weakness of rupee during mid-2013
may be useful. The Indian rupee went into a tailspin in July-August 2013 and recorded its
lowest level of 68.34/USD on 28 August 2013. It recovered to 60.10/USD on 28 March 2014.
Both weak economic fundamentals and speculation contributed towards the rupee weakening
in mid-2013. Policy logjam, sudden stop of capital inflow, rising inflation, high CAD and
strengthening USD, in general, were the main factors responsible for the rupee weakening.
Until August 2013, the policy prescription of arresting the fall in rupee was to control dollar
demand; however, this did not yielded desired results.
However, with the change of the guard at RBI in September 2013, the policy focus shifted to
the augmentation of supply of the US dollar. Some control on runaway gold imports and
reduction in policy uncertainty also helped and the rupee staged a smart recovery by FYE14.
The Indian rupee turned out to be one of the best performing currencies compared with the
most fragile currency in mid-2013.
Drivers of Exchange Rate
Economic Fundamentals and Outlook
Economic sentiments have improved considerably with the outcome of the general election
2014 in favour of a stable government. Macroeconomic indicators such as GDP growth,
inflation, current account and fiscal deficit are likely to perform much better in both FY15 and
the medium-term compared with FY13 and FY14. Although a lot will depend on how quickly
India resolves the supply issues which affected its growth in FY13 and FY14.
While global recovery is still fragile and uneven, the outlook for the US economy is better than
last year’s. India and the US are the only two large economies of the world where IMF’s
September 2014 growth projections are higher than April 2014 projections. Earlier fears of an
immediate Fed rate hike are now eased and it is widely expected that Fed rate hike cycle will
start from mid-2015 with odds in favour of a gradual rate hike. Clearly, the tapering off of QE is
35
40
45
50
55
60
65
70
Aug 98 Jun 00 Apr 02 Feb 04 Nov 05 Sep 07 Jul 09 May 11 Mar 13 Dec 14
(INR/USD)
Currency Movement
Source: Reserve Bank of India
Fear of euro zone break-up
Euro zone debt crisis
Likelihood of Fed tapering of QE
Strengthening of US dollar index
and RBI intervention
Related Research
Economic Recovery: Gradual but on Course Rupee: Light at the End of the Tunnel
Macro Research
Conundrum of Indian Rupee
January 2015 3
over and unlike mid-2013 the rupee withstood tapering off without any turbulence. Ind-Ra
expects GDP to grow at 5.6% and average WPI inflation to decline to 2.7% in FY15. It also
expects interest rate to decline to 7.8%-7.9% by FYE15.
Current Account and Capital Inflow
Currency movement is closely linked to the level of CAD and capital inflow. Although CAD in
FY15 is likely to be higher than in FY14 (1.7%), capital inflow is estimated to be more than
sufficient to finance the deficit. Ind-Ra expects foreign exchange reserve to increase by
USD15.0bn in FY15. CAD in FY13 increased to 4.7% of GDP from 2.7% in FY11. This along
with a slowdown of capital inflow resulted in weakening of the rupee. CAD in 1HFY15 came in
at USD17.9bn (1HFY14: USD26.9bn) and forex reserve increased by USD10.0bn (down
USD14.8bn). Yet rupee depreciated by 1.7% yoy during 1HFY15 and depreciated by another
2.6% between October and December 2014.
Global Factors: Strengthening of US Dollar
Global development particularly the status of USD in relation to other currencies is another
factor that dictates the movement of rupee. BUSDI (trade weighted against 26 major trading
partner of US, January 1997=100) appreciated 3.2% yoy in 2014 and between January and
December 2014, it appreciated by 9.0%. Strengthening of BUSDI has a strong negative
correlation with the rupee-dollar exchange rate and results in rupee weakening. BUSDI for
December 2014 (110.4) is at 69 months high. Unlike mid-2013 when the rupee touched a
record low due to the fear of QE tapering and domestic factors, this time around the
depreciation in the rupee was mainly due to the strengthening of USD against other major
currencies of the world and not the other way round.
Figure 2
Movement of Major Currencies with respect to USD USD appreciation (+)/depreciation (-)
Countries Weights in US
dollar index Beginning January 2013 and
end-December 2013 Beginning January 2014 and
end-December 2014
Argentina 0.599 32.1 31.0 Australia 1.261 17.0 9.4 Brazil 2.139 14.5 14.1 Canada 12.658 7.5 9.4 Chile 0.866 9.8 15.3 China 21.292 -3.1 0.5 Colombia 0.655 9.0 21.9 Eurozone 16.377 -4.1 13.4 Hong Kong 1.303 0.0 0.1 India 1.966 12.9 3.3 Indonesia 1.056 26.8 2.1 Israel 1.026 -6.5 12.8 Japan 6.901 21.5 13.9 Malaysia 1.482 7.6 6.6 Mexico 11.870 1.1 12.7 Philippines 0.548 8.0 0.9 Russia 1.368 7.4 71.9 Saudi Arabia 1.029 0.0 0.0 Singapore 1.791 3.8 4.8 South Korea 3.874 -1.2 4.0 Sweden 0.666 -0.1 21.3 Switzerland 1.734 -2.7 11.3 Taiwan 2.397 3.4 6.2 Thailand 1.394 7.5 0.6 United Kingdom 3.348 -1.5 6.6 Venezuela 0.398 46.7 0.1 BUSDI 100.000 3.1 9.0
Source: Federal Reserve, www.oanda.com and Ind-Ra
During January-December 2014, barring Saudi Riyal, USD appreciated against all currencies of
USDI (Figure 2). Appreciation was sharp against Russian, Argentinian, Columbian, Swedish,
Macro Research
Conundrum of Indian Rupee
January 2015 4
Chilean, Brazilian, Japanese, Eurozone Israelis, Mexican and Swiss currencies.
RBI’s Intervention in Forex Market
India broadly follows a managed float, whereby RBI intervenes in the forex market only to
control unusual volatility. RBI is not an exception as central banks across the world intervene in
the currency market to reduce volatility in their currencies. During the periods/years of strong
capital inflow and outflow, RBI’s intervention in the forex market was very high. In FY08, the
regulator made a net purchase of USD78.2bn of foreign currency from market to check rupee
appreciation. In FY11 and FY12, it intervened in the currency market to control the rupee
depreciation and sold USD20.1bn and USD2.6bn, respectively.
However, RBI’s intervention in FY14 had two entirely opposite trends. In 1HFY14, it sold
USD13.8bn in the currency market to defend depreciating rupee. However, after capital started
flowing in after October 2013, it in 2HFY14 made a net purchase of USD22.8bn. In fact, the net
purchase of foreign currency by RBI in November 2013 (USD10.1bn) was highest since
January 2008 (USD13.6bn). Even during April-October 2014, it made a net purchase of
USD19.4bn to arrest rupee appreciation.
As the value of currency has a significant bearing on exports, preventing unusual volatility in its
value to keep the country’s exports internationally competitive has been one of the important
policy objectives of RBI. However, lately it appears that RBI has started focusing on Consumer
Price Index-based REER instead of nominal effective exchange rate (NEER) of rupee. Based
on REER, the fair value of rupee is estimated to be in the range of INR61-62/USD. RBI’s recent
intervention in the currency market is focused towards maintaining the rupee in this band,
although November 2014 REER (36-currency bilateral trade weighted) suggests that the rupee
is still overvalued by close to 10%.
NEER depreciated 3.3% between April-November 2014, while REER depreciated 5.9%. This
was due to higher inflation in India than trading partners’. However, REER is stable now with
inflation declining lately. Ind-Ra expects the inflation to remain benign in the near to medium
term. As this will provide stability to REER, RBI’s intervention in the currency market would be
based mainly on capital inflow and CAD.
Figure 3
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4REER (LHS) NEER (LHS) RBI intervention (RHS)
36 Country Trade Weighted REER, NEER and RBI's InterventionSince 2HFY14, RBI's intervention has been to limit appreciation of rupee
(FY05=100)
Source: RBI, CSO and Ind-Ra
(USDbn)
Macro Research
Conundrum of Indian Rupee
January 2015 5
Appendix
Movement of Currencies in BUSDI against USD
Figure 4 Figure 5
Figure 6 Figure 7
Figure 8 Figure 9
90
95
100
105
110
115
120
95
100
105
110
115
2 J
an
13
2 M
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2 M
ay 1
3
2 J
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3
2 S
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13
2 N
ov 1
3
2 J
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14
2 M
ar
14
2 M
ay 1
4
2 J
ul 1
4
2 S
ep
14
2 N
ov 1
4
USD Index (LHS) USD/CAD(RHS)
(Jan 1997 = 100)
Canadian Dollar
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
95
105
115
125
135
145
95
100
105
110
115
2 J
an
13
2 M
ar
13
2 M
ay 1
3
2 J
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3
2 S
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13
2 N
ov 1
3
2 J
an
14
2 M
ar
14
2 M
ay 1
4
2 J
ul 1
4
2 S
ep
14
2 N
ov 1
4
USD Index (LHS) USD/JPY (RHS)
(Jan 1997 = 100)
Japanese Yen
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
90
95
100
105
110
95
100
105
110
115
2 J
an
13
2 M
ar
13
2 M
ay 1
3
2 J
ul 1
3
2 S
ep
13
2 N
ov 1
3
2 J
an
14
2 M
ar
14
2 M
ay 1
4
2 J
ul 1
4
2 S
ep
14
2 N
ov 1
4
USD Index (LHS) USD/EUR (RHS)
(Jan 1997 = 100)
Euro
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
85
95
105
115
95
100
105
110
115
2 J
an
13
2 M
ar
13
2 M
ay 1
3
2 J
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3
2 S
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13
2 N
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3
2 J
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14
2 M
ar
14
2 M
ay 1
4
2 J
ul 1
4
2 S
ep
14
2 N
ov 1
4
USD Index (LHS) USD/KRW(RHS)
(Jan 1997 = 100)
South Korean Won
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
90
100
110
120
130
95
100
105
110
115
2 J
an
13
2 M
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13
2 M
ay 1
3
2 J
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3
2 S
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13
2 N
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3
2 J
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14
2 M
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14
2 M
ay 1
4
2 J
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4
2 S
ep
14
2 N
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4
USD Index (LHS) USD/AUD (RHS)
(Jan 1997 = 100)
Australian Dollar
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
95
100
105
110
115
120
95
100
105
110
115
2 J
an
13
2 M
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13
2 M
ay 1
3
2 J
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3
2 S
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13
2 N
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3
2 J
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14
2 M
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14
2 M
ay 1
4
2 J
ul 1
4
2 S
ep
14
2 N
ov 1
4
USD Index (LHS) USD/MYR(RHS)
(Jan 1997 = 100)
Malayasian Ringgit
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
Macro Research
Conundrum of Indian Rupee
January 2015 6
Figure 10 Figure 11
Figure 12 Figure 13
Figure 14 Figure 15
90
100
110
120
130
140
150
160
170
180
95
100
105
110
115
2 J
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13
2 M
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13
2 M
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3
2 J
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3
2 S
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13
2 N
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3
2 J
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14
2 M
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14
2 M
ay 1
4
2 J
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4
2 S
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14
2 N
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4
USD Index (LHS) USD/ARS (RHS)
(Jan 1997 = 100)
Argentine Peso
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
0
20
40
60
80
100
120
95
100
105
110
115
2 J
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13
2 M
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2 M
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2 J
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2 S
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13
2 N
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2 J
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14
2 M
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14
2 M
ay 1
4
2 J
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4
2 S
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14
2 N
ov 1
4
USD Index (LHS) USD/MXN(RHS)
(Jan 1997 = 100)
Mexican Peso
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
90
95
100
105
110
115
95
100
105
110
115
2 J
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13
2 M
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2 M
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2 J
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3
2 S
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2 N
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3
2 J
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14
2 M
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14
2 M
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4
2 J
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4
2 S
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14
2 N
ov 1
4
USD Index (LHS) USD/GBP (RHS)
(Jan 1997 = 100)
British Pound
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
95
100
105
110
115
95
100
105
110
115
2 J
an
13
2 M
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13
2 M
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3
2 J
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2 S
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2 N
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3
2 J
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14
2 M
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14
2 M
ay 1
4
2 J
ul 1
4
2 S
ep
14
2 N
ov 1
4
USD Index (LHS) USD/PHP (RHS)
(Jan 1997 = 100)
Philippine Peso
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
90
100
110
120
130
140
95
100
105
110
115
2 J
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13
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2 M
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2 J
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2 S
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2 N
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14
2 M
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2 M
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4
2 J
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4
2 S
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14
2 N
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4
USD Index (LHS) USD/BRL (RHS)
(Jan 1997 = 100)
Brazilian Real
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
90
110
130
150
170
190
210
230
95
100
105
110
115
2 J
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2 N
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2 M
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2 M
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4
2 J
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4
2 S
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14
2 N
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4
USD Index (LHS) USD/RUB(RHS)
(Jan 1997 = 100)
Russian Ruble
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
Macro Research
Conundrum of Indian Rupee
January 2015 7
Figure 16 Figure 17
Figure 18 Figure 19
Figure 20 Figure 21
95
105
115
125
135
95
100
105
110
115
2 J
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2 M
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2 M
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2 J
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2 N
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2 J
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14
2 M
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14
2 M
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4
2 J
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4
2 S
ep
14
2 N
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4
USD Index (LHS) USD/CLP (RHS)
(Jan 1997 = 100)
Chilian Peso
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
95
100
105
110
95
100
105
110
115
2 J
an
13
2 M
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13
2 M
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3
2 J
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2 S
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2 N
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2 J
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14
2 M
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14
2 M
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4
2 J
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4
2 S
ep
14
2 N
ov 1
4
USD Index (LHS) USD/SGD(RHS)
(Jan 1997 = 100)
Singapore Dollar
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
95
100
105
95
100
105
110
115
2 J
an
13
2 M
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13
2 M
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3
2 J
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2 S
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13
2 N
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3
2 J
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14
2 M
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14
2 M
ay 1
4
2 J
ul 1
4
2 S
ep
14
2 N
ov 1
4
USD Index (LHS) USD/CNY(RHS)
(Jan 1997 = 100)
Chinese Yuan
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
99
100
101
95
100
105
110
115
2 J
an
13
2 M
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13
2 M
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3
2 J
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2 S
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2 N
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3
2 J
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14
2 M
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14
2 M
ay 1
4
2 J
ul 1
4
2 S
ep
14
2 N
ov 1
4
USD Index (LHS) USD/SAR(RHS)
(Jan 1997 = 100)
Saudi Riyal
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
95
100
105
110
115
120
125
130
135
140
95
100
105
110
115
2 J
an
13
2 M
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2 M
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2 J
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3
2 S
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13
2 N
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3
2 J
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14
2 M
ar
14
2 M
ay 1
4
2 J
ul 1
4
2 S
ep
14
2 N
ov 1
4
USD Index (LHS) USD/COP (RHS)
(Jan 1997 = 100)
Colombian Peso
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
95
100
105
110
115
120
125
95
100
105
110
115
2 J
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13
2 M
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13
2 M
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2 J
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2 N
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3
2 J
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14
2 M
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14
2 M
ay 1
4
2 J
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4
2 S
ep
14
2 N
ov 1
4
USD Index (LHS) USD/SEK (RHS)
(Jan 1997 = 100)
Swedish Krona
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
Macro Research
Conundrum of Indian Rupee
January 2015 8
Figure 22 Figure 23
Figure 24 Figure 25
Figure 26 Figure 27
90
100
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130
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115
2 J
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2 M
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2 M
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2 N
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3
2 J
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14
2 M
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14
2 M
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4
2 J
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4
2 S
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14
2 N
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USD Index (LHS) USD/INR (RHS)
(Jan 1997 = 100)
Indian Rupee
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
90
95
100
105
110
95
100
105
110
115
2 J
an
13
2 M
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2 M
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2 J
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2 S
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2 N
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3
2 J
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14
2 M
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14
2 M
ay 1
4
2 J
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4
2 S
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14
2 N
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4
USD Index (LHS) USD/CHF (RHS)
(Jan 1997 = 100)
Swiss Franc
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
95
105
115
125
135
95
100
105
110
115
2 J
an
13
2 M
ar
13
2 M
ay 1
3
2 J
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3
2 S
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13
2 N
ov 1
3
2 J
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14
2 M
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14
2 M
ay 1
4
2 J
ul 1
4
2 S
ep
14
2 N
ov 1
4
USD Index (LHS) USD/IDR (RHS)
(Jan 1997 = 100)
Indonesian Rupiah
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
95
100
105
110
115
95
100
105
110
115
2 J
an
13
2 M
ar
13
2 M
ay 1
3
2 J
ul 1
3
2 S
ep
13
2 N
ov 1
3
2 J
an
14
2 M
ar
14
2 M
ay 1
4
2 J
ul 1
4
2 S
ep
14
2 N
ov 1
4
USD Index (LHS) USD/TWD(RHS)
(Jan 1997 = 100)
New Taiwan Dollar
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
80
85
90
95
100
105
110
95
100
105
110
115
2 J
an
13
2 M
ar
13
2 M
ay 1
3
2 J
ul 1
3
2 S
ep
13
2 N
ov 1
3
2 J
an
14
2 M
ar
14
2 M
ay 1
4
2 J
ul 1
4
2 S
ep
14
2 N
ov 1
4
USD Index (LHS) USD/ILS (RHS)
(Jan 1997 = 100)
Israeli New Shekel
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
90
95
100
105
110
95
100
105
110
115
2 J
an
13
2 M
ar
13
2 M
ay 1
3
2 J
ul 1
3
2 S
ep
13
2 N
ov 1
3
2 J
an
14
2 M
ar
14
2 M
ay 1
4
2 J
ul 1
4
2 S
ep
14
2 N
ov 1
4
USD Index (LHS) USD/THB(RHS)
(Jan 1997 = 100)
Thai Baht
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
Macro Research
Conundrum of Indian Rupee
January 2015 9
Figure 28 Figure 29
99.85
99.95
100.05
100.15
100.25
95
100
105
110
115
2 J
an
13
2 M
ar
13
2 M
ay 1
3
2 J
ul 1
3
2 S
ep
13
2 N
ov 1
3
2 J
an
14
2 M
ar
14
2 M
ay 1
4
2 J
ul 1
4
2 S
ep
14
2 N
ov 1
4
USD Index (LHS) USD/HKD (RHS)
(Jan 1997 = 100)
Hongkong Dollar
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
90
100
110
120
130
140
150
95
100
105
110
115
2 J
an
13
2 M
ar
13
2 M
ay 1
3
2 J
ul 1
3
2 S
ep
13
2 N
ov 1
3
2 J
an
14
2 M
ar
14
2 M
ay 1
4
2 J
ul 1
4
2 S
ep
14
2 N
ov 1
4
USD Index (LHS) USD/VEF(RHS)
(Jan 1997 = 100)
Venezuelan Bolivar
Source: US Fed, www.oanda.com
(2 Jan 2013 = 100)
Macro Research
Conundrum of Indian Rupee
January 2015 10
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