Since the violent move up in USD/INR beginning August 2011, stakeholders have been nervous about INR's prospects. India's current account deficit (CAD) has deteriorated sharply from $46 billion in FY11 to an expected $98 billion in FY13. In addition, given India's weakened economic situation, there are questions on the capital inflow front as well. India's gross domestic product growth has weakened from 9.3 per cent in FY11 to an expected 5.2 per cent in FY13. Inflation and fiscal deficit have remained high through the period. The level of external debt has increased well beyond the country's currency reserves. The domestic microeconomic situation has worsened as well, giving a weak undertone to our equity markets. From what was initially a slowdown in investments, we now seem to have a broad based consumption slowdown. Finally, the recent sharp weakening of JPY (Japanese yen) and other Asian currencies has spurred fears of fresh weakness in INR.
In the midst of all this gloom, there are a few positives for INR, going forward. The first is on the exports front. The resilience of the US private sector appears to be overcoming the much-feared fiscal stress. With stabilising land prices, an emerging energy supply story and cash-rich corporates, the US appears to be well positioned for the onset of a strong investment cycle. Likewise, China, Japan and Europe have belied doomsday prophesies as well. All this should bode well for India's exports in the current fiscal - we must remember that INR has depreciated significantly against its Asian and emerging market peers, over the last three years.
Secondly, India's commodity import bill should reduce over time. Global commodity prices - particularly energy - remain subdued. This could be a medium term trend on the back of the energy supply story emerging in North America. To energy importers like India, this can be a strong positive. In addition, the silent and creeping correction in domestic energy prices across diesel, petrol, LPG and kerosene already appears to be moderating domestic energy consumption, witness the data for the first two months of this year. There is a similar story on gold as well - with international prices looking soft, it is conceivable that our fascination for gold as an investment option would temper, going forward. Gold imports have had a large negative role to play in our current account deficit.
Thirdly, the market is probably better prepared now for INR depreciation, than it was in August 2011. Foreign currency liabilities and payables are probably better hedged now, and exporters have by and large reduced hedge ratios. Forward premia for USD/INR is at multi-year highs. Arguably, the market would probably be more caught unawares by USD/INR moving down to 50, than going up to 60.
The one weakness remains on the growth front - particularly with respect to infrastructure investments. With elections due latest next year, and with several infrastructure projects stuck awaiting review and approvals, this remains the soft underbelly of India's prospects. One hopes that policy action - both from the government and the Reserve Bank - can help unshackle some of these restraints.
I think USD/INR should continue to remain in a 53 to 56 range. As and when the infrastructure investment question is addressed, I would personally be bullish on the rupee's prospects. However, given the high degree of volatility over the last two years, risk managers have to seek insurance against violent market moves.
The author is co-head of wholesale banking, South Asia, Standard Chartered Bank. Views expressed are personal.
