Short Note on the Rupee's Slide

The Indian rupee has fallen to new record lows against the US dollar today. While the rupee's 1.8% slide against the greenback is the largest since Sept '11, it represents continuation of the trend that started in May. 

Indeed in the first three months of the year, the rupee was among the strongest of the emerging market currencies, gaining about 1.3% against the dollar. It was bolstered by foreign inflows into India's stock markets and the belief that Federal Reserve's QE was going to keep risk assets, including emerging markets well supported.

Two things have happened.  First, the market has begun anticipating the end of QE and this has seen US rates rise and an unwind of some of the flows to emerging markets.  Second, there has been a deterioration of India's macro economic fundamentals.  

Foreign investors bought about $38.5 bln of Indian sovereign and corporate bonds in Q1.  Since then they have sold about $2.5 bln.   Equity flows have fared better.  Foreign investors bought $10.15 bln of Indian equities in Q1 and have bought another $5.15 bln thus far in Q2.    The depreciating rupee undermines the return on fixed income investments more than equity investments.   Indian equities are mostly flat on the year, but are up about 3.25% here in Q2.  

India's currency reserves have fallen $8.7 bln this year and appear poised to decline for the third consecutive year.   Indian officials have signaled the lack of desire to intervene to support the rupee, which would entail the sales of dollars.  

The central bank has cut key rates by 75 bp this year to 7.25%.  It is expected to leave rates on hold when it meets next week.  Inflation figures--both consumer and wholesales prices--are due out this week.  Consumer prices are trending lower form 10.9% in February and are below 9.5% in April for the first time since last spring.   The May print is expected to be just above 9%.  

Wholesales prices are falling faster.  They peaked near 8% in Q4 12 and in April stood at 4.89%, the lowest since late 2009.  The knock-on effects of higher fuel prices, especially diesel, and the weaker rupee may contribute to stickier prices.  

The combination of a large current account deficit (~5% of GDP), coupled with negative real rates (deflated for CPI) and the general unwind of emerging market flows, is taking a toll on the rupee and the government seems reluctant to resist.  It is taking some measures, like making it more difficult to import gold and reducing barriers for foreign portfolio investment, but nothing to alleviate the near-term pressure on the currency.  

The dollar is uncharted waters against the rupee, which means there is no obvious resistance.  It has closed above the top Bollinger Band, set at 2 standard deviations above the 20-day moving average.  Although the returns in the currency market are not normally distributed, this is a rare event in any case.  The dollar has been carving out a large triangle pattern on the week bar charts and the initial projection of the break out is INR60-INR61 (currently quoted ~INR58.135).