The rupee is a risk that cannot be ignored! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

The rupee is a risk that cannot be ignored! 

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In this issue:
» Are you buying gold for the right reasons?
» How long can dollar save the US economy?
» Foreign fund inflows make Indian markets vulnerable!
» ONGC stake sale could be an opportunity loss for the Govt
» ...and more!

00:00  Chart of the day
The value of a nation's currency is a barometer for its economic health. It was almost a year back when rupee touched record lows of around 68 per dollar. The fall was a response to India's poor economy, further sparked by the Fed's move to taper its asset purchases. Since then, the rupee seems to have made a comeback. This could be attributed to an improvement in economic data such as shrinking current account, capital inflows and as well as proactive monetary policy.

However, at around 60.3 per USD, rupee is quite far from its fair value. The recent Economic Survey suggests that with consumer price index (CPI) and 2004-2005 as base, rupee is overvalued by around 12.3% in real effective exchange rate.

One should note that some of the key reasons behind the decline in current account deficit were restriction on gold imports and weak rupee (that promoted exports). An overvalued rupee amidst high inflation could be risky. It could negate the benefits from lower current account deficit. This is because a rising rupee will make India's exports less competitive. Since exports account for a major share in GDP, this could have serious implications for economic fundamentals.

Exports are our best bet as far as economic recovery is concerned. Amid high inflation, the consumption factor is unlikely to contribute much. With an ambitious fiscal deficit target and limited funds, expecting a quick turnaround in investment cycle will be naive. As such, there is a significant threat to economic recovery on the currency front. This is something that both the policymakers and investors need to watch out for. Especially with concerns like Iraq crisis and monsoon deficit threatening the recovery prospects.

Meanwhile, investors should shield themselves against any development that could adversely impact economic and market sentiments. And as far as volatility of paper currencies are concerned, there can be no better hedge than gold. Hence, we reiterate our stance that investors should have some part of their overall investment portfolio allocated towards gold.

Do you think a rise in rupee could have severe repercussions for India's economic recovery? Let us know in the Equitymaster Club or share your comments below.

Rupee valuation poses a key risk to India's economic recovery, Equitymaster

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Of the major investment assets where people park their hard-earned money, gold stands out as a favorite in India. The history of rising gold prices has lured many people to invest in gold in the hope of even higher prices. We are not at all against gold investments. In fact, we believe they ought to be an important component of a person's investment portfolio. However, we differ on one fundamental aspect about gold. And this is how you look at it and what you expect out of it. Gold, in our view, is not a productive asset. It does not create wealth. But it performs a very critical function. It helps to preserve wealth in times of distress. What do we mean by distress? This could mean reckless government policies, high inflation and unforeseen catastrophes. Yes, gold has always come in handy as an insurance against bad times.

Take the case of the Malaysian airplane that was shot down yesterday near the Russia-Ukraine border. The tragedy killed 298 people on board. And this event could further escalate tensions between Russia and the West. The news of the plane crash brought nervousness in the Asian stock markets. But the shiny, yellow metal inched higher. This is what gold does. It serves as the safe haven during times of crisis.

If you're looking for quick speculative gains on gold, then maybe you should stay away. But if you subscribe to our philosophy about gold as a long term hedge against external risks, then gold should certainly comprise at least 10-15% of your investment portfolio.

After the death of the gold standard, the existence of the US dollar was under threat. With the dollar-gold peg being abandoned, dollar's reserve currency status was under question. However, contrary to popular belief, the US dollar has blossomed all the more. That's because contenders like Euro and Yuan were unable to displace it.

The fact that dollar is a world reserve currency has given the US a freehand to print money. And thereby inject liquidity into world market. It can run perpetual deficits unlike other countries since it can pay dollar bills at its own will. This coupled with the near zero interest regime has turned on the liquidity tap in emerging markets. Hot money has made its way to these economies upsetting the price-fundamental relationship amongst stocks. Excessive liquidity has also created currency volatility in these economies.

In short, survival of the dollar has salvaged the US of what could have been an irreparable damage to its economy post gold standard. Not only that, it has also created asset price bubbles elsewhere. Dollar's reserve status has enabled the US to enjoy unconditional privilege until now. But it would be interesting to see till when this joy ride continues.

As stocks markets across the world are inching higher, voices are also getting louder about how valuations across certain pockets might be in bubble territory. The biggest irony is that many of those commenting on the frothiness in the markets are the central bankers themselves. Consider for instance the comments made by the US Fed chief Janet Yellen as reported in The Mint. According to her, "valuation metrics in some sectors do appear substantially stretched-particularly those for smaller firms in the social media and biotechnology industries." The US Fed and other central bankers of the developed world have largely been responsible for following loose monetary policies since the 2008 global financial crisis. Far from improving the fortunes of their respective economies, these easy money policies have only inflated asset prices. As a result of which there is a huge disconnect between prices and the ground reality. The impact of this has not been lost on the RBI as well. Indeed, this flush of liquidity has found its way into the Indian stock markets as well, which continue to remain vulnerable to the quantum of foreign fund inflows or outflows as the case may be. It will be interesting to see how central bankers will choose to react when this frothiness reaches epic proportions. Most likely the response will be the same like it was for the 2008 crisis: print more money.

If you buy things you don't need, you will soon sell things you need, goes the famous Buffett aphorism. We sort of sense this coming true in what the Government after Government has done with respect to India's great PSUs. It is no secret that India's finances are in a mess. And in order to bring the fiscal deficit in check something will have to be done. However, instead of ensuring fiscal discipline, what every finance minister has done is resort to stake sale in some of the best PSUs in the country. And this includes the current regime as well. However, what is even more shocking is in its hurry to make the fiscal math add up, it is not even trying to get the best value out of stake sale. Take ONGC for example. With few reforms in place, the Government can easily double the bounty it will currently earn from selling partial stake in the oil exploration behemoth. In other words, the Rs 600 bn it is trying to raise can easily go up to Rs 1,200 bn if an article in Firstbiz is to believed. But looks like the Government is hardly bothered. Of course, there is an urgent need to plug the fiscal gap. But this can also be achieved through sale of other non-core assets. Using ONGC would mean greatly underutilising its immense potential and transferring tax payer wealth into the hands of private investors. However, this is not how a Government should function.

Infrastructure development in India is paramount. And long term funding is a must have if the projects worth trillions of rupees are to take off. The government and regulators are completely in sync with this vision. However, it is the execution that will matter the most. And that is where the hiccups could be! Initially the UPA government was of the view that a vibrant bond market will help support infrastructure funding. Currently, inadequate supply of paper from corporate, who tend to borrow cheap abroad, has kept the bond market illiquid. Further, there is lack of transparency on bond yields. Even the regulation of the bond market leaves a lot to be desired. Amidst this there are views that facilitating banks to lend to infrastructure could be additionally harmful for the bond markets. That the reserve requirements of banks will be waived for infra lending has not gone down well with the bond market experts. According to us, the bond markets alone cannot do enough to fund India's infra aspirations. Hence while the government should ensure more infra related bonds, banks can certainly lend a helping hand.

In the meanwhile, the Indian stock markets remained volatile. At the time of writing, the BSE-Sensex was trading higher by 58 points (+0.2%). Majority of the sectoral indices were trading in the red with realty and power stocks being the major losers.IT and banking were among the few stocks trading positive. Barring China and Indonesia, most of the Asian indices were trading in the red led by Japan. European markets have also opened on a weak note.

04:56  Today's investing mantra
"Time is on your side when you own shares of superior companies." - Peter Lynch

Editor's note: Please note there will be no 5 Minute Wrapup tomorrow on 19th July 2014.
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2 Responses to "The rupee is a risk that cannot be ignored!"


Jul 19, 2014

I read somewhere tat govt. has stake in ITC?y isn't it selling that...


nalin patel

Jul 18, 2014

it is our wrong following of west, we have to explore alternative to petroleum oil, we have 75% of world's thorium with us we have not tapped this resource, thorium is low pressure very safe material to handle and very simple in technology, go on youtube and search thorium powered car and thorium reactors, we must act now and stop foreign drain of dollars

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