August 22, 2019
pakistan is fighting alone against india
The rupee has now depreciated by about 7 percent from June 2018, when the Reserve Bank of India (RBI) started hiking rates, and close to 13 percent in 2018.
Thus, by any stretch of the imagination, the depreciation in the rupee has now outpaced other Asian currencies like Indonesia rupiah. We believe, beyond a certain level of depreciation, the costs could outweigh benefits. There are many components of such cos.
Short-term external debt repayment:
India’s short-term debt obligations as on December ’17 were to the tune of $217.6 billion. Assuming half of this amount has either been paid in H1 2018 or is rolled over to 2019, the remaining repayment amount in rupee terms would be Rs 7.1 trillion at average 2017 exchange rate of Rs 65.1/ US dollar).
For H2, assuming that rupee depreciates to an average value of the 71.4/US dollar, the debt repayment amount would be Rs 7.8 trillion, thereby implying an extra cost of Rs 670 bn.
This is a model estimate of the cost that depreciation can put on the country as the repayment is done throughout the year.
Oil import bill:
The next is the impact on oil import bill. We assume that the volume of our crude oil imports would increase by a modest 3.6 percent (average of past 5 years) in 2018.
If we reduce the volume of oil imported in the first half of the current FY, the remaining volume of crude to be imported comes to 0.76 bn bbl.
At an average oil price of $74.24/bbl for the remaining half, crude import bill of India in 2018 should amount to $57 billion. If the average exchange rate remained at Rs 65.1/ US dollar the crude oil import bill would have been Rs 3,643 billion.
However, with rupee depreciating to an average of Rs 71.4/US dollar in H2 2018 end, the import bill would increase to Rs 4036 billion, implying an extra cost of around Rs 0.353 trillion.
With crude oil averaging to $76/bbl for the remaining half and average exchange rate at Rs 73/ US dollar, the extra cost could go up to Rs 457 billion
As per RBI, a depreciation of the Indian rupee by around 5 percent relative to the baseline, inflation could edge higher by around 20 bps. With rupee expected to depreciate by say around 14 percent this year, keeping everything else constant inflation could edge by 56 bps going by the RBI numbers.
If the rupee continues to depreciate, it may move RBI towards increasing the regulatory interest rates. This could pressurise RBI to go for more rate hikes. RBI’s successive rate hikes will have a negative impact on consumption expenditure (PFCE) as well as investment expenditure, thereby widening the output gap.
For instance, during FY14, 3 successive rate hikes led to the collapse of private consumption expenditure to 2 percent in Q3 FY15 from 8.6 percent growth in Q2 FY15.
During Q1 FY19, PFCE increased by 8.6 percent (6-quarter high) and RBI has already hiked Repo rate in two successive rate hikes. The continued rupee depreciation and given the significant costs of RBI intervention in the forex market and hence the RBI apathy to take that route could result in at least one more hike, possibly frontloaded.
With yields crossing 8 percent, there will be increased fiscal costs on the part of the government every year. We expect such costs to be at least Rs 6000-7000 crores. Interestingly every year, Government generally frontloads the borrowing programme to the H1.
For example, in FY14-FY18, the central government frontloaded on an average 59% of borrowing programme, that has declined to 39% in current fiscal. State Government’s borrowing trend is similar to Central Govt.
This was mainly to avoid the rising interest costs to the Government. However, as a result, there will now be increased borrowing pressures on the government and hence yields will increase from current levels.
Now a word on the efficacy of exchange rate depreciation in promoting exports. We empirically estimated the relationship between exchange rate and exports from Jan’07 to Jun’18 and the results from the macro data shows that the relationship between these two are very weak.
The historic trend suggests depreciation of exchange rates could boost exports growth by 2 billion (US $) / Rs 150 bn on an average in the long run.
EXPECTED LEVEL OF RUPEE: NDF AT 75:
In the offshore NDF markets, the rupee is trading at Rs 75 per dollar levels. During this financial year the rupee has depreciated sharply; with NDF implied yield on rupee hardening sharply from 6.5 percent to 7.7 percent in September.
The last 364 day T-bill cutoff was 7.32%. Thus, the rupee will continue to face pressure in foreseeable future.