Rupee Rally to Falter on Current-Account Deficit: India Credit

Rupee Rally to Falter on Current-Account Deficit
The biggest rupee rally in 15 months may be coming to an end as a widening current-account deficit erodes the benefits of surging inflows of overseas investment. Photographer: Scott Eells/Bloomberg

The biggest rupee rally in 15 months may be coming to an end as a widening current-account deficit erodes the benefits of surging inflows of overseas investment.

The shortfall in the broadest measure of trade and investment flows tripled in the second quarter from a year ago to a record $13.7 billion, a central bank report showed today. The currency, which has climbed 4.7 percent this month, will drop 1.2 percent by Dec. 31, a survey shows.

A wider deficit increases pressure on Reserve Bank of India Governor Duvvuri Subbarao to protect exporters and slow rupee gains by buying dollars and delaying interest-rate increases, according to Barclays Plc, the world’s third-biggest currency trader. Kokusai Asset Management Co. said any weakness may be temporary. The rupee survey signaled the currency may resume its rally next year, gaining 5.3 percent in 2011.

“The RBI has a tough task striking a balance between inflows, exchange rate and controlling inflation,” said Rahul Bajoria, a Singapore-based economist at Barclays. “The deficit will increase the headwinds and lead to a weakening of the rupee in the short term.”

Relative Strength

The rupee touched 44.835 a dollar this week, its strongest level since May 4, after gaining 6 percent from an eight-month low reached on May 25.

Trading patterns signal a possible reversal, after the rupee’s so-called relative strength index rose to 77.6, from 37.3 at the end of last month, according to data compiled by Bloomberg. Readings above 70 indicate a currency may have risen too fast.

The last time the reading was above 70 was in April, just before the rupee weakened to 47.7450 in May from 44.1875 on April 10. The currency may end the year at 45.5 and strengthen to 43.23 by December, 2011, according to the survey.

India’s 10-year bonds held at their highest level in six weeks yesterday on speculation slowing inflation will prompt the central bank to pause interest-rate increases. Inflation as measured by wholesale prices held above 10 percent for four months since March before slowing to 8.5 percent in August, according to commerce ministry data.

Narrowing Spread

The yield on the 7.8 percent note due May 2020 was 7.85 percent as of the 5 p.m. close in Mumbai yesterday, according to the central bank’s trading system. The price was at 99.68 per 100 rupee face amount. The was no trading today for half-yearly closing of bank accounts.

Yields on India’s 10-year notes are poised to fall this month relative to U.S. Treasuries for the first time since May in a sign that investors have greater confidence in India. The difference in yields was 5.34 percentage points yesterday, compared with 5.48 percentage points at the end of August. The measure has ranged from 3.74 percentage points at the start of the year to 5.56 percentage points on Aug. 26.

India yields compare with 12.06 percent in Brazil, 7.62 percent in Russia and 3.35 percent in China, according to data compiled by Bloomberg. Similar debt offer 2.46 percent in the U.S., 0.92 percent in Japan, 2.22 percent in Germany and 2.91 percent in the U.K.

Slowing inflation and rising foreign demand for India’s stocks will bolster the rupee, said Takahide Irimura, the head of emerging-market research in Tokyo at Kokusai Asset Management.

Stock, Bond Purchases

“The rupee may continue to outperform the other regional currencies in the short term,” Irimura said in a telephone interview from Tokyo on Sept. 28.

Overseas investors bought $18.2 billion more Indian shares than they sold this year, while debt purchases reached a record 471.3 billion rupees ($10.5 billion), according to data provided by the Securities & Exchange Board of India. Net foreign direct investment, according to government estimates, is likely to jump 52 percent to $30 billion in the year to March.

Higher sovereign ratings have helped fuel the rally in the rupee, making it the best performer this month after the Korean won among the top 10 most-traded currencies in the region outside Japan. The won has gained 5.1 percent.

Moody’s Investors Service increased India’s local-currency credit rating one level to Ba1, the highest non-investment grade, in July as the government vowed to make the sharpest cuts in its budget deficit in 19 years. That was the first upgrade since 1998 and places India on par with Greece, Egypt and Morocco.

Current-Account Deficit

The current-account deficit in the fiscal year ending March 31 may widen to a record $57 billion, or 3.6 percent of gross domestic product, according to Barclays’ estimates. The gap was $38.4 billion the previous year, or 2.9 percent of GDP.

The International Monetary Fund estimates Brazil will have a deficit of 2.2 percent of GDP in 2010, while China and Russia may show a surplus of 6.2 percent and 5.1 percent.

The central bank’s Subbarao said Sept. 20 that it’s a “dilemma” to manage capital flows and the nation needs “just enough to meet the current-account deficit.” He said in a speech in the southern city of Hyderabad that it isn’t possible to simultaneously have free movement of capital, a fixed exchange rate and an independent monetary policy.

The Reserve Bank intervenes in the market “only to smooth volatility, which is harmful to trade and investment,” Subbarao said in a speech in Washington on April 26. The central bank “doesn’t comment on the day-to-day movement of the rupee,” said Alpana Killawala, a spokeswoman for the central bank.

‘Temporary Problem’

The surge in the current-account gap is a “temporary problem,” and will moderate to 2 percent of GDP during the next 12 to 18 months, said Chetan Ahya, an economist at Morgan Stanley in Singapore. Morgan Stanley expects the rupee will weaken to 47 to the dollar by the end of March.

Imports rose faster than exports as India’s 8.8 percent growth last quarter, the best among major economies after China, stoked demand for oil and other goods.

A sputtering recovery in developed nations prompted Infosys Technologies Ltd., the nation’s second-largest software exporter, to cut prices to retain customers as it reported a drop in profit in the three months ended June 30.

Overseas purchases of merchandise goods climbed an average 44 percent this year from the same period in 2009, while sales of the nation’s goods abroad grew about 20 percent, according to data provided by the trade ministry. The monthly trade deficit averaged $10.6 billion this year, a record.

“Despite the fact that capital inflows have risen on the back of strong growth and higher domestic borrowing costs, we view sustained currency appreciation as unlikely,” said Barclays’ Bajoria, who expects the rupee will depreciate to 47.5 per dollar by March.

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