The rupee under pressure

SMARTSHARE

Fundamentals eventually assert their influence on price-trends. But prices can move irrationally in the "wrong" direction for months after the fundamentals change. This is why fundamental players need deep pockets and tons of patience.

For a year now, the rupee has been under pressure. It has fallen about 6-7 per cent against the US dollar in the past 12 months. What's more, the weakness is certain to continue. It's driven by a combination of factors which cannot really be controlled or reversed.

One: India is running a large, growing trade deficit "" this is due to high crude and gas prices. There's nothing the GoI can do about this in the short-term. In the long-term, a build-up of excess refining capacity could help balance the net deficit on the POL account through the re-export of petroleum products. That won't happen in full-fledged fashion until 2009-2010 however.

Two: The US Federal Reserve has maintained its policy of raising interest rates despite the change of guard. The Bank of Japan may impose a Yen interest rate for the first time in six years when it concludes a crucial two-day policy meeting this week.

India cannot raise its own rates sufficiently to maintain the current rupee-Yen or rupee-dollar rate differentials without imposing brakes on its own GDP growth. Hence the interest rate differential is now less attractive for foreign investors and inflows may slow. That will put additional pressure on the rupee.

A weak rupee causes obvious problems on many fronts. It hurts net importers and it makes it tough for the RBI to juggle accounts. It makes external debt-servicing difficult. But there is a silver lining in the form of higher export competitiveness.

There is a multiplier effect to a weaker rupee for exporters. It isn't a linear relationship; dollar earnings don't gain 1 per cent in rupee terms for every 1 per cent fall in the rupee. Exporters can quote lower rates leveraging a weak rupee and thus, grow the overall volume of business.

This is obvious. The biggest beneficiary from a weaker rupee is also obvious; the poster boys of Indian exports are the "invisibles generators" of the IT and BPO industries.

Their business volumes grow and their bottomlines grow every time the rupee falls. Given that input costs are mainly in rupees and in the form of overheads rather than raw material costs, they have greater pricing flexibility than product exporters.

Fundamentalists have been touting IT-BPO stocks since January 2006 when the trends became apparent. Nevertheless, the CNX IT index has consistently underperformed the broad market in the past year.

Since July 2005, the Nifty has risen 43 per cent while the CNXIT has risen 27 per cent and since January 2006, the Nifty has returned 11 per cent while the CNXIT has returned 8 per cent. The change in fundamentals did not influence price-trends for over six months despite excellent results from IT frontliners and good advisories about future prospects as well.

However, prices may finally be realigning with fundamentals. The trigger appears to have been the Infosys Q1 results and the more optimistic advisories that accompanied those workings. The market has responded by a surge of buying across the IT-BPO universe.

Over the next six months to a year, IT stocks could move counter to the apparently bearish market cycle and they may be excellent hedges until such time as the forex outlook changes.