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Rupee cushion

12 December 2011 By Jeff Glekin

The rupee is the worst performing currency in Asia. It has fallen more than 17 percent this year against the dollar. India relies on capital inflows to fund its current account deficit, but self inflicted wounds and investors’ worries about troubles elsewhere have been driving capital away. New Delhi, already in turmoil, is running out of firepower to deal with the impact.

Capital flight is the last thing India needs. Its annual financing requirement of $119 billion is the highest in Asia, according to a report by Nomura. The trade deficit for the fiscal year ending March 2012 is expected to sharply widen to $155 billion-$160 billion from $104.4 billion a year ago.

Many Indians used to believe that capital would always continue to flow inwards, but in 2010 India was the only BRIC country to experience a decline in foreign direct investment (FDI). In 2011, the combined inflows from FDI and institutional investors declined from $16 billion in the first quarter to only $4 billion in the second.

The decline of the rupee now threatens to create a negative spiral. India imports more than three-quarters of its oil requirements and oil accounts for two-thirds of the country’s import bill. A rupee depreciation creates inflationary pressure and hits businesses’ operating costs. The government also partially subsidies domestic oil consumption, so any decline in the rupees costs it more too. This is putting pressure on the fiscal deficit which looks like it will breach 5 percent of GDP this year.

Furthermore, the rupee decline creates financial stress for Indian companies which have borrowed in dollars. The list includes Reliance Communications, Suzlon and Tata Motors. In total, Indian companies face a short-term foreign debt maturity of $16 billion for the year ending in March 2012, according to Crisil, the Indian rating agency.

The government looked to be trying to turn investor sentiment in a positive direction this month when it announced the opening of the retail sector. The embarrassing subsequent reversal has only made investors even more wary of the India story. The rupee still looks vulnerable.

 

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