In-depth analysis on Credit Writedowns Pro.

India: rupee in freefall, stagflation setting in, risks of sovereign downgrade and investor panic rising

By Sober Look

This is beginning to sound like a broken record, but India’s currency has come under severe pressure – again. India’s central bank, the RBI, seems to have completely lost control over the rupee. The currency broke through 67 to the dollar this morning – a level that was difficult to fathom just a few months ago.

Dollar rising vs. the rupee (source: Investing.com)

This is hitting the domestic economy hard. Just when the Indian consumer spending has slowed, prices are about to rise – potentially rapidly. Here is an example.

The Economic Times: – Indian companies such as Whirlpool of India Ltd say they can’t plan more than a couple of months out as a fast-falling rupee currency drives up the cost of imports, forcing them to raise prices even as consumer spending crumbles.

The timing is particularly tough for consumer companies that were counting on India’s September-to-December holiday season to spur sales. India’s consumers, whose spending helped see the country through the global financial crisis in 2008, are closing their wallets, squeezing companies from carmakers to shampoo sellers.

Companies that import finished goods or raw materials are the worst hit as they scramble to hold onto margins while balancing the need to raise prices without deterring buyers.
“We are now planning for a month or three months at best unlike six months or a year earlier,” said Shantanu Dasgupta, vice president for corporate affairs and strategy at Whirlpool of India, the local arm of Whirlpool Corp, the world’s largest home appliance maker.

One would think that with this type of currency depreciation, India’s exports should help with economic growth. Not quite.

BW: – It’s standard macro-economics: When a country’s currency declines, its exporters should soon get a boost as the lower currency makes their goods more competitive. By that rule, India should be enjoying an export boom. Since the start of May, the currency has dropped 23 percent, making it one of the world’s worst performers. Sure enough, exports did go up in July, rising 11.6 percent year-on-year, the best increase in more than 12 months.

Consumers worldwide shouldn’t expect to see a surge in Made-in-India products in the coming months, however. The July increase comes after a period of weakness: India’s exports dropped 1.8 percent in the 2012-13 fiscal year. And while the currency has been steadily weakening for two years, the decline of the rupee hasn’t helped narrow India’s current-account deficit. Instead, the trade gap has just gotten bigger, hitting 9 percent of gross domestic product in the first quarter. “The sustained and large depreciation of the [rupee] since mid-2011 does not appear to have had any near-term impact on the current-account deficit,” Mumbai-based Goldman Sachs economist Tushar Poddar wrote in a report published on Aug. 26. Chances of a short-term rebound driven by a weaker currency are “doubtful,” he added.

And now two risks of serious collateral damage from this devaluation are becoming increasingly real:  (1) a sovereign ratings downgrade and (2) the equity market collapse due to foreign investors’ full blown panic.

JPMorgan: – The stagflationary impact of such depreciation is well-known. But, more worryingly, markets have now begun to question whether the currency has entered a zone that could prompt more serious events. Two clear event risks are now appearing on the horizon. First, more currency weakness and its damaging consequences on the fiscal deficit have re-ignited concerns about a sovereign rating downgrade. Second, the risk of a sharp equity outflow has increased. Foreign equity investment is four times that of debt in India, and sustained corporate stress and slowing growth is testing equity investors’ patience. 

At this stage, rising prices, sharply higher interest rates (see post), and a loss of confidence within the business community will bring the economic growth to a standstill, potentially pushing the country into a full blown stagflation.

About 

Sober Look is a no-hype financial markets/macro blog that typically relies on data analysis, primary sources, and original materials. We keep it concise, to the point, with no self-promoting nonsense, and no long-winded opinions. If you are looking for Armageddon predictions or conspiracy theories, you will be thoroughly disappointed. Topics include financial markets, banking, asset management, risk management, derivatives, global economy, policy, and regulation, with the emphasis on finance education. Follow him on his blog or twitter.