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Rupee depreciation: A mixed bag

Jun 24, 2004

The expected upward revision in the Fed funds rate has led to nervousness in the global stock market, as a hike in interest rates in the US could lead to flow of dollars out of the markets. Through this article, consider how a rate hike in the US will impact the Rupee/Dollar exchange rate and which sectors could benefit from the same. Before going any further, one has to understand the one of the key reasons behind the stock market rally last year, not only in India but also in the global market. In order to boost economic recovery, the Fed was reducing interest rates. This combined with other monetary adjustments translated into large flow of dollars in the global markets. The historic inflow of Foreign Institutional Investors (FIIs) money into the Indian stock market has to be viewed in this context. One has to borne in mind that the rise in stock prices was not just unique to India but also in the global markets. It is important to understand that the rally was not just restricted to equities but also other asset classes like commodities, gold and so on. Given this backdrop, it is apparent that significant liquidity was one of the reasons why the Indian stock markets saw significant FII inflow. Of course, there were other fundamental reasons as well. But the liquidity factor cannot be ignored.

Now, what will happen if interest rates were to rise in the US market? A rise in US interest rates (say India) could result in an increase in the amount of funds flowing back into the US, as investors will be attracted to the higher dollar rates of interest. This will result in an appreciation of the US dollar as compared to Indian rupee. But to say that how much will be the appreciation in dollar be due to increase in interest rates will be difficult because in practice, the exchange rate is influenced both by expectations about future interest rates and any unexpected changes in interest rates.

Against expectations that the rupee will strengthen during FY05, in the recent past, the rupee has actually depreciated significantly. So, which sectors will benefit from such a trend? At the end of the day, when rupee depreciates, sectors that are export driven will benefit in terms of higher revenues. The impact would vary. Say, for the software sector, it could be beneficial whereas for the oil sector, it is a negative on account of crude imports.

Top contributors*...
Sector (% of India's exports)
Readymade garments 9.6%
Chemicals 10.1%
Textiles 10.4%
Agriculture and allied products 11.7%
Gems & jewellery 16.7%
Engineering goods 19.4%
(*Apr-Feb'04, CMIE, only the commodity basket)

To start of with, major software companies like Wipro, Infosys and Satyam derive 90% of revenues from exports. Any upside in the value of US Dollar will have a positive impact on these companies topline. Since most of the costs are in rupee terms, the appreciation will filter down to the bottomline. Having said that, software companies generally hedge most of their dollar exposures and to that extent, the impact may not be immediate. However, new client additions are likely to be lucrative, provided the rupee depreciation remains a reality. So, other things being same, 1.0% rupee depreciation will have around 0.9% increase in the company's revenues. Just to put things in perspective, dollar has appreciated around 5% in last one month.

While in the pharma sector, companies have a varied international exposure. Ranbaxy and Dr Reddy's have higher export contribution (80% and 65% respectively), whereas companies like Cipla derive 40% of revenues from exports. Textile companies are also likely to benefit. Arvind Mills export more that 50% of its output. However, other things being same, on the cost front, Raymond may suffer, as it imports wool for its fabric division.

Top contributors*...
Sector (% of India's imports)
Textiles 1.6%
Chemicals 8.2%
Gold & silver 8.7%
Electronic goods 9.7%
Capital goods 12.7%
Crude and products 26.7%
(*Apr-Feb'04, CMIE, only the commodity basket)

One of the biggest losers of this rupee depreciation will be refining companies like HPCL and BPCL that import around 62% and 50% of the crude requirements. So in rupee terms, the cost of imported crude will be higher and these companies may not be in a position to pass it on to the consumers. However, ONGC will be benefited as its products are priced in Dollar terms.

For the country as a whole, the rupee depreciation is likely to increase the cost of crude imported. This could have a negative impact on the overall fiscal situation of the country, which already has come under significant pressure. Overall, the rupee depreciation story is sector specific and it is a mixed bag.

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