Bearish Rupee Bets at ‘08 High as Confidence Ebbs: India Credit

Bearish Rupee Bets at ‘08 High as Confidence Ebbs
A worker labors in a factory which produces oil from cotton seed in Wankaner, India. Factory output fell 5.1 percent in October from a year earlier, the first decline since June 2009. Photographer: Adeel Halim/Bloomberg

International investors are boosting bets that India’s rupee will extend the worst slide since 2008 as an economic slump deepens, suggesting a lack of confidence in the central bank’s steps to curb exchange-rate volatility.

Twelve-month non-deliverable forward contracts on the rupee dropped 2.6 percent this month to 56.19 per dollar even as the Reserve Bank of India introduced measures to boost dollar supply and curb rupee sales. Forwards fell as much as 6.5 percent below onshore spot rupee prices yesterday, the deepest discount since 2008, data compiled by Bloomberg show. Similar contracts signal a 0.8 percent drop in China’s yuan and a 1.1 percent decline for South Korea’s won.

Bond risk in India has surged the most among the largest developing nations this year as the rupee’s 15.3 percent tumble threatens to further fuel inflation that’s already more than 9 percent, according to CLSA Asia-Pacific Markets. The sliding rupee is also boosting costs for Indian companies, faced with a record $11.4 billion of dollar-bond repayments in 2012.

“While the RBI has taken decisive steps to reduce speculation, these measures don’t necessarily address the underlying cause for the rupee’s weakness,” Olivier Desbarres, head of foreign-exchange strategy for Asia-Pacific ex-Japan at Barclays Capital in Singapore, said in an interview on Dec. 16.

The rupee, the worst performer against the dollar among Asian currencies and of the so-called BRIC nations in 2011, plunged to a record low of 54.305 per dollar on Dec. 15, poised for a third straight quarter of declines, data compiled by Bloomberg show.

Worst of BRICs

Brazil’s real lost 10.7 percent this year to 1.8598 per dollar and the Russian ruble retreated 3.8 percent to 31.74. The Chinese yuan gained 4.1 percent to 6.3395. The rupee may slide to 60 per dollar next year, according to CLSA and Skandinaviska Enskilda Banken AB.

Currency options signal further declines in the Indian currency. Implied volatility on three-month dollar-rupee options, a gauge of expected exchange-rate swings, doubled in the second half of 2011 to a 19-month high of 14.2 percent this week, data compiled by Bloomberg show.

Similar-dated contracts offering the right to sell the rupee against the dollar cost 350 basis points more than those to buy today, compared with 115 at the end of June. The so-called risk reversal rate was 71 basis points for the yuan, 475 for the ruble, and 800 for the real.

‘Not Real Money’

“This is a sign of rupee weakness driven by foreign investors,” Dariusz Kowalczyk, a senior strategist at Credit Agricole CIB in Hong Kong, said in a phone interview on Dec. 13. “Offshore forwards are leading onshore forwards. This means it is possibly not real money.”

Forwards are agreements to buy or sell assets at a set price and date. Non-deliverable contracts are settled in dollars on currencies that are traditionally not easily convertible for foreign investors.

The rupee has rebounded 2.9 percent from last week’s lows after the Reserve Bank restricted trades in onshore forward contracts to temper speculation and freed interest rates on dollar deposits held locally to spur fund inflows.

Companies can’t enter into multiple forward contracts to cover a single overseas transaction, the central bank said on Dec. 15. The monetary authority eased rules for overseas borrowings by microfinance companies on Dec. 19.

‘Other Measures’

Last month, policy makers relaxed rules for firms to sell foreign currencies through swaps. They also sold dollars in recent weeks to curb the rupee’s slide, according to Mumbai-based IndusInd Bank Ltd. The central bank sold $943 million of foreign currency in October, compared with $845 million in the previous month, data on its website show.

“These are not the only measures we have,” Reserve Bank Deputy Governor Subir Gokarn told reporters in Mumbai on Dec. 20. “There are other measures we can undertake to bring stability to this market. But for the moment, clearly some degree of stability has returned, and that’s important.”

Indian local currency-denominated debt has returned 6.3 percent this year, compared with the 17 percent earned on Brazilian real bonds, JPMorgan data show. Chinese notes returned 6 percent, while Russia’s gained 5.4 percent, the data show.

The rupee fell more than other Asian currencies as India’s economy slowed and Europe’s debt crisis spurred capital outflows from developing nations. India is more vulnerable as it has Asia’s widest current-account deficit.

Investor Exodus

Factory output fell 5.1 percent in October from a year earlier, the first decline since June 2009, government data showed last week. Governor Duvvuri Subbarao, who has raised borrowing costs 13 times since early 2010 to stem inflation, left rates unchanged on Dec. 16 to support the slowing economy.

Global investors pulled almost $20 billion this year from the stock markets of India, South Korea, Taiwan and Thailand, exchange data show. India’s current-account shortfall widened to $14.2 billion in the three months ended June 30, from $5.4 billion in the first quarter, government data showed.

The gap may widen to 3.5 percent of gross domestic product in the year ending March, Commerce Secretary Rahul Khullar said this month. India’s GDP was $1.7 trillion in 2010, according to the World Bank.

“The RBI’s measures, along with some intervention, will buy time for the country to address medium-term issues such as the current-account deficit and capital outflows,” Ananth Narayan G., Mumbai-based head of South Asia currency and bonds trading at Standard Chartered Plc in Mumbai. “Those are the root causes of the rupee’s weakness.”

Bond Risk

Yields on 10-year government bonds climbed 41 basis points, or 0.41 percentage point, in 2011. The yield on the 8.79 percent note due 2021 fell one basis point today in Mumbai to 8.33 percent, according to the central bank’s trading system. Rupee-denominated bonds returned 6.5 percent in 2011, compared with the 20.5 percent earned by Indonesian debt, HSBC Holdings Plc indexes show.

The cost to protect the debt of State Bank of India against non-payment has surged the most this year since 2008 as the rupee weakened. Credit-default swaps on the state-owned lender jumped 234 basis points in 2011 to 395 basis points, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. China’s government bonds increased 80 to 152, while those for Russia climbed 126 to 273 and Brazil’s added 53 to 164.

Retail Investment

The swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. State Bank is viewed as a proxy for India by investors as the nation doesn’t have dollar-denominated debt.

The central bank predicts Indian inflation, which slowed to 9.11 percent in November from 9.73 percent the previous month, will slow to 7 percent by March.

“Since inflation is on an easing path, investors are betting on a cut in interest rates in the coming months,” N.S. Venkatesh, head of treasury at Mumbai-based IDBI Bank Ltd., said in an interview on Dec. 16. That is “encouraging for bond investors.”

Overseas funds boosted holdings of rupee-denominated government and corporate debt by $8.16 billion this year to a record $25.8 billion on Dec. 20, exchange data show. Investors still demand extra yield of 637 basis points to hold India’s 10-year sovereign notes over similar-dated U.S. Treasuries.

The central bank’s latest measures show “the commitment of the RBI to fight further rupee depreciation,” Sebastien Barbe, chief emerging-market strategist in Paris at Credit Agricole CIB, said in an interview on Dec. 15. “I think this draws a line in the sand at close to 54 per dollar.”

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