Rupee Seen on Slippery Path as Volatility Highest: India Credit

India’s rupee is seen swinging the most among global currencies as Westpac Banking Corp. and Credit Agricole CIB say government efforts to buoy the currency by boosting offshore borrowing are misguided.

Three-month implied volatility, a measure of expected moves in the exchange rate used to price options, jumped 649 basis points this quarter to 19.14 percent, the highest among 48 global currencies tracked by Bloomberg. The rupee has plummeted 18 percent this year in Asia’s worst performance.

Finance Minister Palaniappan Chidambaram aims to contain the current-account deficit at $70 billion in the year through March 2014 and said at least $11 billion will be funded through non-rupee liabilities. The government will ease rules for overseas corporate loans, make state-run companies sell bonds offshore and incentivize Indians living abroad to deposit more foreign currency with the nation’s banks, he said Aug. 12.

“Increasing foreign-exchange liabilities is an easy way for policy makers to try and balance the currency market,” Dariusz Kowalczyk, a Hong Kong-based strategist at Credit Agricole CIB, said in an Aug. 27 e-mail interview. “However, it’s a slippery path at a time when structural reforms are not in place, and markets seem to have lost patience.”

The Reserve Bank of India said in a report last week the nation’s debt-servicing needs “may pose a concern” for the shortfall in the broadest measure of trade. The central bank has identified the deficit as the biggest risk to Asia’s third-largest economy.

$172 Billion

India had $172 billion of debt maturing within 12 months as of March 31, equivalent to about 59 percent of the nation’s foreign reserves, official data show. That’s the highest ratio since at least 2005 and compares with 51.4 percent in Indonesia. The current-account deficit will be narrowed from a record $87.8 billion mainly by restricting gold imports to 850 metric tons this year, Chidambaram said.

“A lot of borrowing offshore is what got them into this mess in the first place,” Jonathan Cavenagh, a strategist at Westpac in Singapore, said in an Aug. 22 telephone interview. “The market needs to see some sustainable steps taken to narrow the current-account deficit before this capital comes in, and we just aren’t there yet.”

Financing pressures have weakened the rupee. The currency fell the most in 20 years to an unprecedented 68.8450 per dollar on Aug. 28 on concern a surge in oil prices amid political tension over Syria will worsen India’s external position and push the economy toward its biggest crisis since 1991.

Payments Crises

Oil-price shocks triggered balance-of-payments crises in India in 1981 and 1991. During those periods of tumult, debt-servicing increased with the help of external commercial borrowings and deposits from non-resident Indians, according to a Dec. 7 speech by RBI Executive Director Deepak Mohanty.

Since Aug. 20, the RBI has exempted banks accepting deposits from overseas Indians from keeping 4 percent of the money as cash and investing 23 percent in approved securities. Such deposits stood at $70.8 billion in the year ended March 31, compared with $58.6 billion in the previous year, RBI data show.

“Non-stable flows,” including purchases of Indian stocks and bonds by foreign institutional investors and short-term credit, comprised more than half of total capital inflows in the last fiscal year compared with one-third in the previous period, according to the RBI’s annual report released Aug. 22.

Currency Reserves

The central bank’s foreign-currency reserves fell to $277 billion as of Aug. 2, the lowest level since 2010, due to currency valuations and as the central bank intervened to defend the rupee. The holdings were $279 billion on Aug. 16, according the latest official data.

“Most of the currency risk sits with foreign institutional investors and non-resident Indians, and the RBI is expending its reserves to protect these investments,” Mirza Baig, head of currency and interest-rate strategy at BNP Paribas SA in Singapore, said in an Aug. 23 telephone interview. “The costs outweigh the benefits.”

Bond risk in India is rising. Credit-default swaps insuring the bonds of State Bank of India against non-payment for five years have climbed 96 basis points since end-June to 371, according to data provider CMA.

Chidambaram’s plan to get state-run companies to sell foreign-currency bonds will boost costs for Indian borrowers as total issuance from the nation will increase, Hemant Dharnidharka, the Bangalore-based head of credit research at SJS Markets, said in an Aug. 22 e-mail interview.

Current Account

India’s current-account deficit will narrow more than the government forecasts, making it easier to fund, according to Barclays Plc. The lender predicts the shortfall could drop to as low as $57 billion, causing the rupee to strengthen to 61 per dollar in six to 12 months.

The currency climbed 3.4 percent yesterday after the RBI said it will sell dollars to state-run oil refiners through swap agreements. It fell 0.2 percent today to 66.7450 per dollar. The yield on the 10-year government bond rose five basis points, or 0.05 percentage point, to 8.83 percent today.

“However, given the present fragile market sentiment, the underlying improvements in India’s current account may go unnoticed,” Siddhartha Sanyal and Rahul Bajoria, Barclays economists in Mumbai and Singapore, wrote in an Aug. 23 report. “Near-term rupee weakness could persist, especially in the absence of policy initiatives to quickly boost capital flows.”

Morgan Stanley

Morgan Stanley estimates borrowings by the 10 most-indebted Indian companies have risen sixfold since 2007 to $120 billion, and a quarter of corporates lack the cash flow to cover their interest payments, according to an Aug. 27 report. India’s import cover has declined to 5.5 months from 14 months in 2007, the report said.

Domestic structural factors are the root cause of the rupee’s drop, while the speed and timing of the plunge is due to speculation about the U.S. paring of stimulus, RBI Governor Duvvuri Subbarao said in a speech yesterday. His term ends next week, and Raghuram Rajan will take charge of the central bank.

“Not so long ago, India was still celebrated as one of the emerging nations destined to rise for the indefinite future,” the report by Morgan Stanley’s Global emerging-markets equity team said. “But behind the scenes the picture was deteriorating.”

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