Predicting the Value of Indian Rupee

INR was under considerable pressure till Nov 2008 and since then the level of INR/USD has stabilized till date. It would be interesting to see how the Indian unit will play out till March 2010. The factors that we would consider for predicting the value of INR against USD are:
1. India is a low ICOR country, as compared to most other emerging nations, especially China. If we apply an ICOR of 4.3x to our predicted GDP growth rate of 7% for FY10, we get autonomous investment of 30.5%. (The actual investment rate can be higher or lower)
2. We predict a savings rate of 31% for India for FY10.
3. This gives an autonomous surplus of 0.5% of GDP for investment – savings gap for FY10.
4. In other words, if required, India can repurchase foreigners’ capital of approximately USD 5 billion in FY10 without affecting her growth rates.
5. The fall in crude oil prices, and expected stability of crude oil at the current level, given extremely dire global conditions, means that India will reduce her oil imports by at 3% of GDP in FY10, as compared to FY09.
6. This fall in crude oil imports can provide good cushion for expected marginal increase in gap in goods export versus non-oil imports.
7. The worsening labour conditions will reduce the propensity for regular remittance inflows. However, we expect that to be compensated by increasing spreads over LIBOR for variety of NRI (non-resident Indian) products, recently allowed by RBI; and also by one-time transfer of accumulated capital by returning Indians.
8. India holds foreign exchange reserves to the tune of 25% of her GDP, while the mismatch in trade and current accounts are predicted to be quite miniscule for FY10.
9. The propensity of foreign capital to exit the country will depend on the relative growth rates in India versus rest of the world, and the level of interest rates in India versus rest of the world. India compares well on both the grounds.
10. Also, the banking system in India is both, liquid and solvent. This is not true for the banking system in USA, UK, Germany, and PIGS. This means that if somebody is looking at a country with respectable growth rates, respectable banking system, low inflation, enforcement of law and order then there is India has to figure in that list.
11. The only negative for India is her high fiscal deficit. However, since India does not depend on foreign capital to meet her Government borrowing needs, this factor should not cause a big worry, when predicting the level of INR.

So, where should INR trade one year in March 2010. This level will not be dictated by the net current or capital flows, as RBI can manage those flows through its reserves. However, RBI may consider depreciating the currency in order to maintain some sort of parity with the movement in other developing countries. Many currencies of other developing countries, especially emerging Europe have been ravaged recently. RBI would be careful in protecting the value of currency during periods of extreme fear like the current conditions show; as it knows quite well that a bleeding currency in the fearful market is like a bleeding person is shark infected water. RBI has spent approximately USD 1 billion per week during last one year in managing the currency movement, and it can continue to do so, if required, for one more year without any significant issues on credibility of doing so. Also, expected disinflation in the domestic economy means that RBI can easily replace the rupees lost during intervention in currency market by providing liquidity through other sources.

So, what is the conclusion? The most likely value for INR in March 2010 versus USD is 50 (current levels) based on India’s own fundamentals. However, RBI will take the currency up or down depending on how other currency pairs, mostly in emerging markets behave. However, the most likely prediction for other currencies is not good. RBI will allow some rub off of this weakness on INR over a period of time, especially during periods of calmness in financial markets. Hence, we can witness stability in INR during extreme conditions in global financial markets and marginal weakness during periods of relative calm in global financial markets.

May be the last point on this topic can be a possibility of SBI issuing a global retail offering at around 6% to 7% dollar coupon if the global financial conditions worsen significantly from here. In that case the US-10-year would have gone below 2%, the policy interest rates in UK and Europe would have gone below 1%, making this offering by SBI an attractive option for investors. For Indian residing abroad, the rating agencies saying India is just one notch above investment grade is not a factor while considering personal investments in India. This can attract significant money if managed well.

The risks to the above forecasts are mainly geopolitical risks:
1. How the unraveling of the failed state of Pakistan, with current establishment of Taliban rule in SWAT will affect India? The above prediction assumes that the world polity will force Pakistan to control Taliban.
2. The possible negative outcome from the general elections in India in May 2009. The above prediction assumes that the new power structure in India will have minimum acceptable economic literacy.