We have experienced in the last one week that what a sudden change in currency dynamics can do to the markets and macros of the economy. Before dwelling into the topic of currency depreciation lets go back in the history and try to understand India’s import-export dynamics :-
- After opening up of economy in 1991-92, the foreign investors were allowed to invest in Indian equities and government bonds. The process and quantum of funds to be invested was relaxed with the passage of time.
- FIIs invested billions of Dollars in equity and bonds. The spurt in foreign exchange increased the reserves of RBI steadily, and thereby allowing India to start importing.
- With increase in imports, the GDP of India also increased steadily and almost reached to double digit. With the growth in GDP, per capita income also increased significantly. This has resulted into a significant rise in consumption from food items to cars and many more.
- Over the years we were not able to produce enough goods to cater to the needs of the growing economy and thereby increasing our imports year on year compared to increase in exports. Since India lacks the geographic advantage, few of the biggest imports are that of oil and gold. However, thanks to the huge inflow from FII in equity and debt which helped us to finance the gap between imports and exports and thereby taking a small impact on the currency.
- During the same time, China emerged as stronger contender as it built it’s foreign exchange reserves through exports and Foreign Direct Investment. While India accumulated foreign exchange through borrowings in the form of debt, bonds, investment in equity, NRI deposits, etc., which is a short term money and will have to be paid back as and when they require.
- Even though our exports increased a significantly, our imports have increased more than that resulting into rise in current account deficit from 2% to 6% in just the previous 3 years. Unfortunately, our government could not introduce the reforms at proper time, to attract more Foreign Direct Investment to shore up our reserves by long term inflow.
- Post 2008, the Dollar flows to India was largely helped by the policy called QE ( Quantitative Easing) by US Federal Bank. To retain the interest rates at low level, it has started to purchase government bonds from the market to the tune of 85 billion USD per month. This huge infusion of liquidity has kept the interest rates in USA at almost 0.25% and helped employment and growth in the economy. Out of this huge infusion of liquidity in USA, a portion(significant one) has flown to emerging countries including India.
- Now since the US Federal Bank is getting the signals of recovery in USA and they wish to discontinue this QE program from September 2013 onwards. This decision of US FED has already started readjustment process of liquidity in the world. The excess liquidity is getting squeezed out and on the back of rising yields in USA, the money is flowing back to USA from India.
- Since our current account deficit used to get financed by the flows of FII, a sudden pull back has got us trapped in a tight spot. FIIs have sold Indian bonds worth 26000 cr. in previous 14 days. This sudden development has put enormous pressure on Indian Rupee which has depreciated from 55 to 60. This trend of selling by FII has also started in equity and the market have thereby crashed.
World over all currencies are depreciating against dollars. However, we need to understand the impact of this depreciation for our economy.
THE IMMEDIATE IMPACT OF DEPRECIATION OF INDIAN RUPEE
- It can impact the confidence of FII in India.
- It can increase our import bill substantially – particularly oil import will become very costly.
- It can raise the inflation as prices of many items including petrol, diesel and gas will be increased meaningfully.
- It can impact the P&L account of many Indian Companies where there is Forex burden.
- The deterioration in macros of economy can lead to re-rating of India which in turn can worsen the situation.
So, one decision of US Federal has started the great re-adjustment of global liquidity and impacted the countries with huge current account deficit very badly.
IN THIS SCENARIO, WHAT SHOULD BE THE STRATEGY OF ANY INVESTOR?
- Investors should look at the companies with minimum forex burden.
- They must readjust their portfolio and add companies having good cash flow and sound future.
- In view of the costly imports going forward, the companies which can produce import substitute will be benefited. The companies with good export exposure are also to be looked into. The technology and pharma companies are to be preferred.
- Investors should avoid companies with huge debt burden and leverage.
It is very important to note here that, in the times of extreme pessimism one should start investing in equities from medium to long term view. Looking to the strength of India to bounce back in bad times and the inherent strength to clock 5 to 6% growth will force global investors to re-look at India and start investing in India once the dust is settled.
The power reforms which the government has initiated recently will bring the power companies in limelight again. The telecom companies are also attractive on back of rise in tariffs.
As Warren Buffett says “ Be greedy when others are fearful and be fearful when others are greedy“, the time to become greedy has come.