Five aspects of Rupee depreciation to keep in mind

by Manshu on May 10, 2012

in Economy

Swapnali posted an interesting comment yesterday which asked why the stock market is negatively correlated to Rupee depreciation even though it’s good for exporters, and I thought I’d broaden that question and write about five aspects of Rupee depreciation that came to my mind looking at his question.

Why is Rupee depreciating in the first place?

Before you get to the effects of Rupee depreciation, you have to consider why the Rupee is depreciating in the first place.

A lot of the downward pressure that’s been on the Rupee in the past few months has been due to the political environment in the country, and the uncertainty caused by issues like GAAR, retrospective taxation, inability to pass any policy reforms and other clouds surrounding the Indian economy.

Unlike the last time the Rupee depreciated which was a time of global crisis, things aren’t as bad globally this time, and most of the trouble that’s brewing is domestic (although things aren’t peachy globally either).

These circumstances hardly inspire investor confidence and as a result money has been flowing out of Indian equities and that’s led to the downfall in the market.

Effect of Rupee depreciation on exporters

If you look at exporters specifically, then all other things being equal, Rupee depreciation is good for them as the conversion rate is higher but the problem is that all other things aren’t equal and they have to face a slowing market in Europe and US, and that means that business is slowing down for them there. The recent Cognizant 2012 guidance, and the drop in share prices of all IT firms subsequently is a good example of that.

Effect of Rupee depreciation on oil bill

This one is the most talked about and I’m sure everyone has heard about this. Since India imports most of its oil from abroad, every time oil prices shoot up, India’s oil bill shoots up and since the government subsidizes oil, the oil subsidy goes up with this.

A lesser known aspect of this is that India has actually got surplus refining capacity, and oil also happens to be India’s biggest export item. While there are price controls in the domestic market, refiners are free to sell at market rates internationally, and that’s led to big oil exports from Indian private oil players, and helps offset some of the big oil bill. In fact in an earlier post about India’s exports in 3 simple charts I spoke of how oil exports might just hold the key to a trade surplus one day.

Effect of Rupee depreciation of Indian funds that hold US assets

Currently, I think there is just one fund in India which is the MOSt Shares Nasdaq 100 ETF which is a practical option to get exposure to the US markets, and this fund has grown about 20% Year to Date but the underlying NASDAQ has just grown 12.6% in that time period.

The remaining gains are due to the depreciating rupee as the stocks that the fund owns are worth more in Rupees now than they were when the fund bought them.

This is a slightly more complex relationship and you can’t really say that Rupee depreciation will always be good for the fund because the other variables that this depends on is how much money flows in the fund at that price level, what kind of redemption takes place at various levels, and how much the fund owns at any given time. I have however seen that the a falling Rupee is good for such funds, and I think if a fund continues to grow its asset under management steadily this would remain true.

Effect of Rupee depreciation on companies that have borrowed in USD

This could potentially become a big problem because a lot of Indian companies borrowed in foreign currency to take advantage of the low interest rates, but didn’t sufficiently hedge to protect themselves against the adverse exchange rate movement that could take place.

Now, they will have to spend a lot more INR to buy the same level of USD they borrowed and not only will this nullify any interest rate savings that they may have benefited from, it will put a big dent on their resources because this is akin to a penalty on the loan.

These are 5 things that come to my mind when I think about Rupee depreciation and these are not necessarily the five most important ones, just the ones that came to my mind as I read the original question.

What did I miss out?

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