UBS Sees Rupee at 70 as Rajan Lacking Magic Wand: India Credit

Pictet Asset Management SA sees no immediate policy fix in India as demand collapses for rupee bonds. UBS AG predicts a further 10.5 percent slump in the nation’s currency.

Yields on 10-year government securities surged 122 basis points in the past month to a five-year high of 9.15 percent as global funds cut holdings of local debt to a 19-month low of $28.7 billion on Aug. 13. The rate on similar Chinese notes rose 32 basis points to 4 percent. The rupee has tumbled 14.7 percent since March and touched an all-time low of 64.12 per dollar today after the Reserve Bank of India slashed the amount companies and individuals can invest abroad last week.

Raghuram Rajan, who replaces Duvvuri Subbarao as central bank governor next month, said Aug. 6 there’s no “magic wand” to solve India’s economic dilemmas immediately. UBS says a drop in the currency to 70 per dollar is possible and Credit Suisse Group AG sees a decline to 65, as slow growth and a record current-account deficit leave Asia’s No. 3 economy vulnerable to a pullout of funds as the U.S. prepares to pare stimulus.

“We are not anticipating that India will take strategic steps that bring sustainable flows in the immediate term,” Philippe Petit, a Singapore-based senior investment manager at Pictet, which manages $30 billion of emerging-market debt, said in an interview on Aug. 16. “The aim should be to accelerate inflows rather than curb outflows. The measures won’t significantly ease the current account situation.”

Failing Efforts

The RBI cut the amount firms can invest overseas without prior approval to 100 percent of net worth, from 400 percent, according to an Aug. 14 statement. Residents can now remit only $75,000 a year versus the previous limit of $200,000. On Aug. 13, India raised tariffs on gold imports and banned inward shipments in the form of coins and medallions to narrow the trade deficit.

The government will allow state financial institutions to issue “quasi-sovereign” bonds abroad to boost capital inflows, Finance Minister Palaniappan Chidambaram said Aug. 12.

The rupee slid 0.7 percent today to 63.60 per dollar, signaling the latest policy changes failed to shore up investor confidence. The yield on the 7.16 percent government notes due May 2023 dropped eight basis points, or 0.08 percentage point, to 9.15 percent. Foreign investors cut ownership of Indian bonds in each of the last 12 weeks as the U.S. signaled plans to scale back stimulus that spurred fund flows into emerging markets.

Not Convincing

“India has not been able to anticipate the difficulties it has faced, be it growth or inflation or the external sector and so the policy responses have not been effective,” Raj Kothari, a fixed-income trader at Sun Global Investment Ltd. in London, said in an interview on Aug. 16. “The current situation is no different now. It gives no reason for investors to believe the rupee’s slide will be curbed now. The past record is far from convincing to put your weight behind the rupee.”

Sun Global, which cut holdings of Indian assets by 3 percent in August, predicts the local currency to fall to 65 by Sept. 30. Pictet is refraining from adding to investments in the country, according to Petit.

Credit risk in India has surged as the currency declined. Five-year credit-default swap contracts insuring the debt of government-controlled State Bank of India, considered a proxy for the sovereign, have risen to 353 from this year’s low of 174 on May 17, according to data provider CMA.

‘Fear of Crisis’

A jump in the cost of hedging against rupee swings is also damping demand for local-currency assets. The price of onshore contracts that fix the conversion rate for buying dollars with rupees in a year’s time has increased to an annualized 8.42 percent from 5.77 percent at the end of June, data compiled by Bloomberg show. UBS Global Asset Management and DSP BlackRock Investment Managers Pvt. said last month higher hedging costs for rupee debt would deter foreigners even as yields increase.

“More and more offshore investors have indicated their fear of an external funding crisis in India, with measures designed to limit capital outflows not helping calm frayed nerves in the markets,” Robert Prior-Wandesforde, an economist at Credit Suisse in Singapore, wrote in a note yesterday.

The RBI could support the rupee through more aggressive currency-market intervention and measures that drain cash from markets such as increases in banks’ cash reserve ratio and the proportion of deposits lenders must invest in government bonds, according to Credit Suisse. Increasing the benchmark repurchase rate, currently at 7.25 percent, would be the “strongest signal of all,” according to the bank.

Current Account

India’s current-account deficit widened to an unprecedented 4.8 percent of gross domestic product in the fiscal year ended March 31, while the pace of economic growth dropped to a decade-low 5 percent, according to official figures.

“Since the macro-economic analysis of India isn’t encouraging, the measures taken recently won’t discourage outflows,” Lutz Roehmeyer, who helps manage the equivalent of $15 billion at Landesbank Berlin Investment, said in a telephone interview on Aug. 16. “The measures don’t substantially address the fundamental issues India faces of slowing growth and increasing current-account gap.”

Options signal currency swings in India will widen further, adding to foreign investors’ risk. One-month implied volatility in the currency surged 319 basis points in the past month to 14.98 percent, signaling a greater potential for losses. Traders quote the gauge, a measure of expected swings in exchange rates, as part of options prices.

India’s efforts aimed at buoying the rupee and winning investors back have been disappointing so far, according to Standard Chartered Plc.

“The market is questioning the effectiveness of policy makers’ moves and the options available to them,” said Priyanka Kishore, a strategist at Standard Chartered in London. “Earlier, the government said it had a grand plan. This is what the market expected, but the final measures disappointed.”

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