India: Rupee and economy

July 16, 2012 at 09:57 am EDT

Since the beginning of the year, the Indian rupee has lost more than 13% against US dollar, defeating efforts of the Reserve Bank of India and showing how Central Banks are sometimes powerless to manage pressure on their currencies. The decline has many causes, such as economy slowdown, deteriorating financial health, flight of capital from emerging markets (stimulated by Government’s weakness), and pressure of inflation.

The GDP grows slower than previous years, last report shows for the first three months of the year a GDP rate of 5.3%, below psychological threshold of 6% and far from 9.2% recorded last year. This is also, the lower rate since nine years. At the same time the important core price index (highest rate among Emerging markets), which not allowed Reserve Bank of India to boost the economy with expansive policy of rate interest cut, which is 8%.

Despite huge investments made recently by Coca Cola and Ikea, more and more foreign capital flights from India. Investors are afraid of worst India’s financial health. As end of 2011, India recorded negative budget balance -7.25% of GDP, worst level ever. The weakness of the local currency against US dollar has damaged also the trade balance (imports are now more expensive for New Delhi). India reported a trade deficit equivalent to 16266 Million USD in May of 2012, led by oil and gold imports. Moreover, to rock the boat the weakness of Indian Government, showing by Sonia Ghandi’s Party (Congress Party), which is slowing down and risks seriously losing next election in 2014, and controversial new proposals about tax foreign investors, which have pulled money out of India’s stock exchange, pressing the rupee at low levels. Besides we have seen many downgrades by 3 rating firms, which had given to Indian credit a negative outlook with a score just above junk bond.

The Rupee fall has started last August and since September the Reserve Bank of India has spent more than $30 billion in foreign reserves and raising them in Rupee, in order to strengthen the local currency. In addition it has recently ordered Indian exporters to convert foreign-currencies into Rupee, and is trying to encourage Indians leaving abroad to place their money in Indian Banks offering higher interest rate on deposit for non-resident. All of these actions not helped the Central Bank the final target of strengthening the Rupee.

The report released today, shows wholesale prices raised 7.25% from a year earlier, compared with 7.55% in May. This data is better than estimates and could lead Reserve Bank of India to take new actions in order to spur economy.

We forecast that USD has hit its zenith against INR last June. The breakdown of support trend line (green line), could push pressure on USD. For this reason we suggest to take a short position on USD against INR, with first target price of INR 51 (target fixed thanks to Andrew’s pitchfork).

USD/INR Cross spot rate, since September 2011