Rupee Drop Fans Inflation Risk as GDP Growth Slows
India’s sliding rupee, the worst performing major Asian currency in the past year, threatens to fuel inflation and limit room to revive an economy where growth probably slowed to levels last seen in the 2008 global crisis.
The rupee is down 18.3 percent against the dollar in the past 12 months, the most in a basket of 11 Asian currencies tracked by Bloomberg that shows a 1.8 percent climb in Japan’s yen and a 2.4 percent advance in China’s yuan. Gross domestic product rose 6.7 percent in the year ended March, matching the pace in the 12 months through March 2009, the median estimate in a Bloomberg News survey shows before a May 31 report.
Investors have pared bets on further cuts in borrowing costs by Reserve Bank of India Governor Duvvuri Subbarao after the first reduction last month since 2009. The cost of locking in interest rates for one year has climbed 17 basis points since April 17, when the central bank lowered its repurchase rate by 0.5 percentage point to 8 percent while flagging price pressures from the rupee, the fiscal deficit and energy costs. Inflation unexpectedly quickened to 7.23 percent last month.
“India is likely to see disappointing growth in the coming quarters, and it seems growth may not exceed 7 percent for the next two-to-three years,” said Dariusz Kowalczyk, a Hong Kong-based strategist at Credit Agricole CIB. “The central bank doesn’t have much room to break the vicious cycle of a weak currency causing high inflation.”
Subbarao pledged last week to take steps as needed to curb swings in the rupee, helping it recover from a record low of 56.3875 per dollar on May 24. The currency strengthened 0.2 percent to 55.25 per dollar as of 10:14 a.m. local time today.
Rupee weakness threatens to boost the cost of imports such as crude oil, intensifying price pressures in a nation already grappling with the fastest inflation among the biggest emerging markets. State refiners including Indian Oil Corp. raised gasoline prices by 11 percent to 73.18 rupees ($1.32) a liter in New Delhi on May 24.
While growth has slowed in countries from Brazil to China as Europe’s debt crisis saps global expansion, domestic risks are also weighing on India’s outlook, contributing to a near 11 percent decline in the BSE India Sensitive Index of stocks in the past year.
Faltering efforts to liberalize the economy and uncertainty over tax changes in March’s budget are among the challenges, deterring investment from abroad. Prime Minister Manmohan Singh is also grappling with a record trade deficit and the widest budget shortfall in the so-called BRIC group of major emerging nations that also includes Brazil, Russia and China.
‘Lack of Policies’
International investors have pulled about $274 million from India’s local-currency bonds since the April 17 rate cut. The yield on benchmark 10-year sovereign debt rose 17 basis points in the period to 8.51 percent, and the extra yield on the notes over U.S. Treasuries widened 41 basis points to 678, according to data compiled by Bloomberg. The cost of locking in interest rates for one year rose four basis points, or 0.04 percentage point, to 8.02 percent last week and was little changed today.
“What is ailing India is a lack of policies that would have opened the capacity of the economy and put India firmly on the global map,” Arun Singh, a Mumbai-based senior economist at Dun & Bradstreet Information Services India Pvt., said in an interview on May 25. “Growth will remain sluggish.”
Citigroup Inc. said last week that “there is now near-consensus that the India story has de-rated.” Goldman Sachs Group Inc. downgraded its growth forecast for the country on May 25, predicting a 6.6 percent GDP increase this fiscal year, down from an earlier estimate of 7.2 percent.
The Reserve Bank of India will probably be unable to lower borrowing costs until October-to-December, Goldman said. Tushar Poddar, an economist at the company in Mumbai, wrote in a note to clients that the RBI will now likely lower interest rates by half a percentage point in the final three months of 2012, compared with the 75 basis points previously forecast.
Asia’s third-largest economy probably expanded 6 percent in the three months through March from a year earlier, the slowest pace since the first quarter of 2009, according to another Bloomberg News survey.
India’s trade deficit swelled to a record $185 billion in the year ended March 31. The shortfall in the current account, the broadest measure of trade, reached $19.6 billion in the three months through December, the most in at least six decades.
The current-account deficit tends to widen when global oil prices rise as the South Asian economy imports about 80 percent of its crude needs. Oil shipments accounted for 32 percent of the country’s $489 billion import bill last fiscal year.
Subbarao said last week that the central bank won’t rule out the possibility of selling dollars directly to oil refiners, a step that may ease pressure on the rupee in currency markets.
He reiterated the central bank’s stance that it will consider inflation and economic growth data before deciding on interest rates at the June 18 policy meeting.
While headline inflation “surprised on the upside” last month, core inflation remains below 5 percent, Subbarao said.
The core reading along with slowing growth may open a window for a rate reduction in June, according to Standard Chartered Plc. Slower global commodity prices and heightened concern about the future of the euro area also support a 25 basis points reduction, said Anubhuti Sahay, an economist at the company in Gurgaon, near New Delhi.
Brent crude, the benchmark for most Indian oil imports, has declined about 6.4 percent in the past year to $107.4 a barrel.
The cost of five-year credit-default swaps on State Bank of India climbed 49 basis points in May to 380 basis points, set for the biggest monthly increase since November, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in privately negotiated markets. Some investors consider the state-owned lender, the nation’s biggest, a proxy for the sovereign. The swaps pay the buyer face value if a company fails to adhere to its debt agreements.
Indian sovereign notes returned 7.4 percent in the past year, trailing the 16.5 percent earned by Indonesian securities in the region’s best performance, indexes compiled by HSBC Holdings Plc show.
The government is seeking to pare the fiscal deficit to 5.1 percent of GDP this fiscal year from 5.9 percent in the year ended March. It plans to sell a record 5.69 trillion rupees of debt this financial year.
“The recent currency depreciation and a potential hike in oil prices will push headline inflation up to 8 percent over the next two to three months,” said Chetan Ahya, an economist at Morgan Stanley in Hong Kong. “The deceleration in growth over the next three to four quarters is unlikely to be accompanied by a commensurate softening in inflation, implying a stagflation-type environment.”
To contact the reporter on this story: Kartik Goyal in Mumbai at firstname.lastname@example.org