With the rupee slipping against the dollar, exporters and IT companies are likely to gain. At a price-earnings ratio of 18.5, CNX-IT could be a value buy.
There are a multitude of reasons underlying the rupee’s weakening versus the dollar. One is the fact that the dollar has strengthened versus most world currencies. A second reason is that India has a large and rising trade deficit, coupled to a large, rising fiscal deficit. The key reason for that trade deficit is dependency on imported crude and gas.
Another contributory factor is that cumulative portfolio investments form a significant proportion of Indian reserves. In January 2008, the net FII contribution to reserves was around $67 billion (equity and debt combined). On September 12, it was around $56 bn. That outflow has surely contributed to pressure on the rupee although reserves remain ample at nearly $300 bn.
Interest rate differentials also suggest that the rupee must weaken. The US 6-month T-Bill is yielding around 1.9 per cent while the 6-month rupee T-Bill yield is 9.07 per cent. The rupee is at 45.44. A ballpark computation at 6-month yields suggests that the rupee should be at around 47 by March 2009, if rates don’t change. A couple of other reasons have also been cited. RBI is going through an organisational regrouping due to the induction of a new governor. Until he is well-settled in office and his views are known, the central bank is not going to intervene heavily in the forex market, barring emergencies.
RBI may be resetting what it considers acceptable limits for rupee movements. Earlier in the year, it was intervening below 43.5 by selling USD. In the past month, it has calmly let the rupee slide till below 45. In fact, the central bank did sell around $2 billion in the past couple of weeks so it is speculative to suggest changes in RBI’s attitude. The other variables are all exhibiting clear trends that suggest a weaker rupee.
Since crude and gas prices have fallen dramatically, it is likely that the projected trade deficit for 2008-09 will improve. A weaker rupee could also bring stronger export growth in its wake and that again, would help cut the deficit. Eventually that will mean a hardening rupee.
If the interest rate situation changes, the rupee-dollar equation would also change. Indian T-Bill yields have dropped noticeably in the past couple of weeks and there’s a yield inversion with the 2017 GoI Sec at 7.9 per cent while the 364 T-Bill is at 8.9 and the 6-month T Bill is at 9.07.
This could signal expectations that the trend of rising rupee rates is now close to peaking. There has also been some sort of recovery in the Bank Nifty driven by such expectations. US yields on the other hand should logically rise following the massive bailout of mortgage lenders Fannie Mae and Freddie Mac.
If rates converge, the rupee will harden. Indian rates are however, quite likely to remain high till the elections.
It’s extremely unlikely that RBI will cut policy rates immediately. Another unpredictable variable is FII attitude going into the future. If the portfolio investors reverse attitude and start buying again, that would boost reserves. It may help to pull the rupee back up since there appears to be some correlation between net FII buys and rupee appreciation.
Amidst all these ifs and buts, it does seem that the rupee is going to close 2008-09 lower than it opened. The factors that could influence a trend reversal and rupee hardening are more likely to work in the longer term while the short-term factors suggest weakening.
That trend of a weaker rupee could mean some windfall gains for exporters. The CNX IT index has been an outperformer in a weak market as that possibility has become more obvious. Anyhow the sector is cash-rich and that’s a huge edge in the current macro-economic conditions.
Most IT guidances have been extremely conservative and there are genuine fears of a weak US economy impacting both topline IT/ITES growth as well as profit margins. The sector has seen lacklustre interest. Most of those estimates have been made with the assumption of a rupee range of about 41. If the rupee trades 10 per cent lower, to around 45, the industry will beat its own projections. At a price earnings of 18.5 the CNX-IT could be a value buy.
