Will the falling rupee hurt your investments?

May 12, 2012

In this issue:
» India's cash deficit set to worsen?
» India does not need any economic stimulus
» Basel III could trigger a recession
» Chinese steelmakers to enter India
» ...and more!

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 Chart of the day
The Indian Rupee has been tumbling down in recent times. There are plenty of reasons being cited for it. Politicians and the government insist that it is due to the weak macroeconomic signals in the broader global economy. The economists say that this is a result of weakening economic conditions in India. Whatever it is, the bottom line remains the same. Indian rupee has weakened. So should you as an investor be worried about it?

The answer is yes. A falling rupee has a direct impact on your investments. Allow us to explain how this happens. When the value of rupee falls, there are two things that happen. First is that the exports from the country become more attractive to global consumers. This means that the exports should go up. When this happens, it is good because the income of the country and hence its GDP goes up. But what happens if the global demand itself is depressed? Well this is exactly what happened with India. The demand from the developed world especially from US and Europe, which are the biggest markets for Indian goods, was depressed during the whole of last year. And it still continues to be depressed. As a result exports remained tepid.

The second impact of the falling rupee is on the imports. Companies that import their raw materials and key items, end up seeing their costs go up. Now during happier times, these companies are able to pass on the increase in costs to their customers. But in times like the ones we are living in right now, domestic demand too continues to be depressed. High inflation as well as high interest rates are some reasons for the same. So when domestic demand is low, these companies find it difficult if not impossible to pass on the increase in costs to the customers. As a result they end up taking a hit on their margins.

The same concept applies to inflation as well. If the rupee devalues, then the country's import bill, particularly its oil bill, goes up. That means that the very dear fuel costs spiral upwards and end up fuelling the inflation in the country. This inflation has its own adverse impact on the investments by depressing the companies' profit margins as well as leading to monetary tightening. If inflation does remain stubbornly high then the Reserve Bank Of India (RBI) may find it difficult to rollback the interest rates which in turn would mean that liquidity remains tight. And capital investments get deferred.

All in all, the falling rupee would have an adverse impact on the investments. Now the question that would come to your mind is what should an investor do? The investors need to do their homework before investing. Identifying companies that have a resilient business model is the need of the hour. And the company has to have pricing power for its goods or services. To add to this if it has fully integrated manufacturing facilities then it would remain insulated from high import related costs to a large extent. Investing in such companies at the right valuations is the key to long term investment gains.

Do you think the falling rupee could hurt your investments? Share your comments with us or post your views on our Facebook page / Google+ page.

Source: Trent

India has abundant reserves of low grade iron ore, which cannot be used for making steel. The country has only 10% of high grade iron ore which is used in steel making. As a result there is a pressing need for steel makers to adopt the pelletisaton technology. Pelletisation is the process of converting low grade iron ore into high grade ore. In order to promote this technology the Indian government has removed export duty on pellet exports. The government has not tinkered with 30% export tax on iron ore announced in December last year. It has now also brought down customs duty to 2.5% from 7.5% on capital equipment. This will spur India's steelmakers to go for pelletisation of iron ore mines in a big way. India has also invited Chinese steel makers to invest in this technology. At present low grade iron ore is exported out of India to the world's largest steel consumer China. This is because very few steel manufacturers and iron ore miners in India have the technology to use it. It is a win-win deal for Chinese steel industry to set up pelletisation plants in India. This would make up for the extra expenditure being incurred by them in view of 30% duty on iron ore exports from India.

Problems for the RBI just don't seem to end. Maintaining a balance between inflation and growth was as it is a tough challenge. Now the central bank has to now deal with the likelihood of a liquidity crunch. There is the possibility that India's liquidity deficit could worsen and hit Rs 1.5 lakh crore in June. For this not to happen either the cash reserve ratio will have to be cut further or there will have to be more open market operations (OMOs). The central bank had already cut the CRR in March this year by 0.75% to 4.75% precisely to ease the structural pressures on liquidity. The other problem is that government spending especially on productive activities has been rather lukewarm. This has been due to policy paralysis which has gripped the government and rendered it ineffective to push through reforms. Ideally, the RBI needs to purchase Rs 350 bn in bonds via OMOs by June. This is if they want to bring down core liquidity deficit to their comfort band. Thus, it remains to be seen how the central bank will manage to achieve this objective.

Stimulus is a word that was quite sparingly used a few years back. But not anymore. No sooner do small clouds start gathering at the horizon, clamor for stimulus begins. Consider India's case. Agreed that India's IIP (Index of Industrial Production) numbers of late have been dismal. But this does not make a case for a fiscal package for the industry. Thus, the Deputy Chairman of the Planning Commission, Montek Singh Ahluwalia, was right when he dismissed this idea. Fiscal stimulus is not the solution as per him. A lot of these things have to do with project implementation, he opined.

We couldn't have agreed more. As per us, what fiscal stimulus ends up doing is that it encourages spending. But savings and the resultant investments is what improves the potential output of an economy. Thus, what is needed is proper execution of existing projects and continuous stream of savings so that the supply side scenario can be improved. Fiscal stimulus is not the answer according to us.

Economic buoyancy, credit growth, savings and investments. Each of these seems to have forsaken the Indian economy over the past year. The last two in particular have been the biggest shockers. True, there is some amount of cyclicality in economy and credit demand. However, at least the savings and investment rates in India had been healthy until 2011. But of late, these two have dipped steadily lower as a percentage of GDP. To begin with high inflation and negative real interest rates dissuaded retail investors from bank deposits. Stocks, debentures and mutual funds too gave jitters. Investors chose to stay away from mutual funds as a result of regulatory flux. All in all, gold and real estate emerged as the only inflation hedging asset classes. Going forward, however, the proposed changes in banking regulations could nearly nail the future of Indian financial sector. Basel III, if implemented in a hurry, could have telling effects on Indian banking. No doubt prudential capital adequacy norms are necessary. They can keep Indian banks free from the liquidity crisis in global markets. However, a hasty implementation could mean choking banks and the economy of necessary capital. This would not only impact GDP growth. But it would also take away investors from financial markets.

It was a disappointing week for world stock markets. Except for Germany all the markets closed the week in the red. The US stock markets were down 1.7% during the week. This was the second straight weekly loss for the US indices. A surprise trading loss of US$ 2 bn by JP Morgan prompted a selloff in the financial stocks. Further, rising political uncertainty in Greece that might cost the country a crucial bail out led to further turbulence in the markets. However, better economic data ensured that the fall was restrained to a certain extent. Claims for the new unemployment benefits fell for the second week fuelling some positivity.

The Indian stock markets were down 3.2% for the week. This was the fourth straight weekly loss as indices lost ground due to contraction in the industrial production data. It may be noted that the industrial output contracted 3.5% in March. Clarification on General Anti Avoidance Rule and RBI directive to exporters to convert 50% of their forex holdings into rupee did not help much in improving market sentiments.

Amongst, the other world markets, Hong Kong was the biggest loser (down by 5.3%) followed by Japan (down by 4.6%). The markets in France and UK were relatively flat registering a fall of 1% and 1.4% respectively.

Source: Yahoo Finance, Kitco, Cnfm

 Today's Investing mantra
"Do not trust financial market risk models. Despite the predilection of some analysts to model the financial markets using sophisticated mathematics, the markets are governed by behavioral science, not physical science." - Seth Klarman

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2 Responses to "Will the falling rupee hurt your investments?"

K.J. Mohata

May 23, 2012

Very good analysis. RBI needs to act fast to arrest Re. slide, otherwise it will have spiraling effect on many things.As it is we are all worried with high inflation. Govt. needs to urgently do the things.



May 12, 2012

Dear Sir,
This an Excellent analysis & by this if our Govt. wakes up & do the right things to arrest the fall of rupee then at least in the future nation may come out of the grips which are slowing down the whole scenario of our nation`s Growth.

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