RBI Cuts Benchmark Rates – Now What?

The much talked about interest rate cut finally happened today. RBI Governor keeping true to his character surprised the markets with an earlier than expected cut taking India on a path different from Russia and Brazil where central banks have increased the benchmark rates in the past few weeks.

I must say it’s a brilliant move by the Governor to put the ball back into Finance Ministers court and push for structural fiscal reforms in the upcoming budget. The general sentiment has been that the higher rates are keeping India from growing which overshadows the fundamental issues of red tape, poor infrastructure and wastage in public expenditure.

The sustained fall in oil prices (thank Russia for occupying Crimea) has given India the much-needed window to push through reforms without being worried about stroking uncontrolled inflation.

The question is that will this rate cut and structural reforms be enough to achieve the targeted growth? No, absolutely not. The other key factor, which should not be ignored, is the exchange rate of the rupee against other currencies. To recap the last year – Rupee has oscillated between 58 and 63.5 against the US dollar (I use USD as a benchmark because the other rates are nothing but a cross rate). The fall in rupee has been less pronounced as compared to its Asian peers like the Malaysian Ringgit, Indonesian Rupiah, Singapore Dollar, Korean Won etc. On the global front, the Yen, Euro and Pound have also dropped sharply against the USD resulting in net gains by the Rupee against these currencies as well.

While the gains in Rupee boost the feel good factor about the India story – is a sustained gain in Rupee the right thing for the Indian economy? My take is that RBI would not let Rupee gain beyond the 62 mark to keep the exports competitive. There was evidence of this when RBI was seen buying dollars in the last week when Rupee gained sharply. With a generally weaker Rupiah, Ringgit, Peso and Riel the Indian exports would face tough competition in areas like garments, IT services, food grains and other manufacturing. Also with Euro and Pound weakening the demand from European countries would decline if the goods are not priced competitively.

With crude oil staying below 50, I think RBI would target the Rupee around 65 against the USD (at-least that’s would I would do, if I were the RBI governor). That would be a roughly 5% decline from the current levels and will bring it at par with other countries with export competitiveness. A sharp gain in the currency would negate any benefit that the lower oil prices would have and I don’t think the RBI or the finance minister would want that.

We should not forget that infrastructure reforms do not happen overnight and take years to fully have the desired impact.

What would that do to SGD INR – 45 mark would remain as the strong support for the pair with upside of Rs.50, but of-course remitting money to India and investing in NRE deposits would always remain a good option.

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6 thoughts on “RBI Cuts Benchmark Rates – Now What?”

  1. Hi Aditya,

    Regarding your comment, “I think RBI would target the Rupee around 65 against the USD (at-least that’s would I would do, if I were the RBI governor)” I think RBI has its own constraints in doing that and there is a trade off. This article explains it nicely

    http://www.moneycontrol.com/news/economy/rupee-rise-may-not-hit-exports-if-global-demand-rises-pros_1289006.html

    Equity and debt flows stood at 45 billion from January 2014 to January 2015. These and other flows could well have taken the rupee to a 5 percent appreciation had it not been for aggressive dollar buying by the RBI. The RBI is believed to have bought USD 80 billion in spot and forward markets year to date in FY15. If one of half of this was bought in the spot market that is USD 40 billion, USD 40 billion worth of rupees sloshing in the system can be inflationary. So RBI absorbed Rs 60,000 crore or USD 10 billion by selling bonds. Rupee appreciation may be a bigger headache for RBI in FY16. With a halving of oil prices, the current account deficit may be zero. If capital flows into Indian equity and debt are again a robust USD 40 billion, the total balance of payment (BoP) flows may be even higher. This will push up the rupee even more. This in turn hurts not just exports, it also makes it cheaper for an Indian shopping online to pick a Chinese good instead of an Indian one thus hurting India’s GDP and Indian jobs. If RBI buys more dollars, it may increase liquidity which can hurt its inflation control objective. Looks like in 2015, rupee appreciation may upstage inflation as RBI’s biggest headache.

    If you remember in 2007 when Rupee appreciated to 38 to the USD, RBI couldn’t do much about it, even though it was badly hurting the Indian exports sector mainly IT and garments.

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    1. Hi Nitin,

      Thanks for sharing. If RBI is unable to keep the rupee competitive then it would be setting a stage for bigger Rupee fall. We all should not forget that after touching 38 rupee steadily weakened and went all the way to 68 over next 4 years. I think China is a great example on how the currency was well managed for years so that exports and efficiencies could grow. The Chinese basically drove the competition bankrupt with favorable exchange rates and India should learn a thing or two to insulate the country from currency shocks.

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  2. Hi Aditya,

    No, UOB report doesn’t say anything about the INR rate. But if SGD indeed reaches 1.4 then even if INR goes to 65 to the USD you still have SGDINR at 46.42. If SGD goes to 1.37 which is highly probable and INR at 65, you still have SGDINR at 47.44, which in my view is the lowest the INR can fall against the SGD. Regarding how high the INR could go v/s the SGD is difficult to predict. If RBI lets the INR appreciate, for whatever reason to 58, we could get SGDINR at 42.33.

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  3. Ok, this is why the SGD suddenly fell to 45 levels against the INR.

    http://www.channelnewsasia.com/news/business/mas-to-slow-appreciation/1620226.html

    “United Overseas Bank said that in view of the lowered Singapore dollar NEER slope, the US-Singapore dollar could trade towards the 1.40-level over the next six months.”

    I know some of my friends who have been bullish on Singapore and bearish on India and still holding on to Sing Dollars at 0% interest in bank accounts here. Good luck to them.

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    1. Hi Nitin,

      Did UOB report say where would INR go in next six months? As far as I know SGD INR have no direct trading and INR’s movement against the USD would be a key component of SGD INR rate.

      One should consider how currencies usually fall when interest rates are reduced and rise when interest rates go up due to interest rate parity.

      Investing in India in a fixed deposit is always a good bet but I would like to caution readers if they are trying to time the market.

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  4. Wow 45 is already here!

    http://www.fxstreet.com/news/forex-news/article.aspx?storyid=c63fb15f-6aea-4957-a802-ca287a97fa5c

    The expectation for SGD now is 1.37 to the USD by the end of the year. INR it is hard to predict.

    However I am now super bullish on Indian equities. I have moved a significant part of my NRE FDs into Indian equity mutual funds, based in India. Now my asset allocation is 35% Indian MFs and 65% NRE FDs. 0% in SGD. I know Indian PE multiples are very high, but the expectation is in 5 years markets will double. Its too risky to be out of equities now, however attractive NRE FD rates may look.

    For my future SGD earnings I am planning to just do a SIP into SG based Indian MFs like Aberdeen India Opportunities fund or other global funds. I dont think I am going to tranfer any more SGDs to India, unless ofcourse the rate again becomes favorable like 47-48.

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