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    To put things quite crudely; we await the rupee's fate

    Synopsis

    We await the rupee’s fate and intensity of pain the economy will go through.

    ET CONTRIBUTORS
    By Abheek Barua

    Let’s get a couple of things straight. The fall in the rupee against the dollar over the past few weeks has gone from being a correction that shaved off some of the overvaluation that had built up to a fullfledged run on the currency.

    Indian exporters may have reason to exult. But on the whole, this disorderly depreciation is bad news for the economy. This is particularly so since the rupee’s fall comes with a rise in a critical and largely imported input: oil. This could both rein in growth and add to inflation, a dangerous mix that every policymaker dreads.

    The uncertainty about where the rupee is headed is compounding the problem. A situation where depending on which analyst you decide to ring, you could get a forecast of anywhere between Rs 67 and Rs 70 to the dollar for the next couple of months. This breeds an environment that makes decision-making for companies (including exporters) and investors extremely difficult.

    Foreign investors vote against this uncertainty with their feet, and simply leave the market. Net foreign portfolio outflows have been over $5 billion since the beginning of April. This itself adds to depreciation pressures and sets off a spiral of capital flight, currency declines and further capital flight.

    The fate of the rupee and the intensity of pain that the Indian economy will go through depends on essentially three factors: the global market, interest rates in the US and RBI’s actions. Currency traders appear fixated on oil prices since every increase adds to India’s import needs. Thus the rupee’s fall is mirroring the rise in oil prices. This brings us to the key question: where would oil prices find a stable equilibriumRs

    The traction in oil prices reflects a number of things: supply cutbacks (by more than their commitments) by both Opec (Organization of the Petroleum Exporting Countries) and non-Opec oil producers, disruptions in Venezuela’s supply that rode on the back of a political crisis, US President Donald Trump’s decision to scupper the Iran nuclear deal raising fears of reduced supply from this heavyweight, and estimates by experts like the International Energy Agency (IEA) that demand in 2018 could be slightly higher than earlier expected.

    A Financial Asset
    Oil is more a financial asset these days that feeds on expectations and investment positions. Thus while even with the adjustments in demand and supply, the fundamental price of oil is around $70 a barrel (Brent crude, the common benchmark), investors are whipping up the froth to take it past $80.

    Whether or not oil stabilises at current levels, and possibly reverses, depends on whether there is good news on the supply side. The Saudis, Kuwaitis and Iraqis could easily commit to making up the losses due to Venezuela and partly Iran. The other signatories to the Iran nuclear pact could commit to sourcing oil from Iran. The US has enough reserves to cool the markets down. The funny thing this time is that the US-—historically a victim of oil price shocks—is not cracking the whip to tame oil prices.

    Why? The answer lies in the fact that if you put fracking and conventional sources together, the US is the second-largest producer of oil in the world. So, while US consumers undoubtedly suffer as they shell out more at the gas station for every gallon of oil, this is offset by the growth in revenues and capital spending. Thus the US will only intervene if the political and economic math suggests a net loss.

    The oil price spike comes at a time when investors have suddenly stopped fretting about the US’s ‘twin deficit’ problem—the combination of large fiscal deficits created by Trump’s tax cuts and spending spree, and its invariable impact on its trade deficit. Instead, they have started focusing entirely on the US’s strong growth prospects in the short term.

    Growth brings in its wake inflation and higher interest rates. Thus US government bond yields have moved sharply up with the 10-year yield crossing the critical 3% mark. Consequently, the incentive to borrow cheap in the US and invest in higher-returning assets like Indian bonds (the so-called ‘carry trade’) has diminished. The new game in town is to sell other assets and take the money back to the US, naturally supporting the dollar in the process.

    Many Questions
    Where the rupee finally settles and finds a degree of stability will depend on whether this sudden sharp turn in sentiment sustains. Will, for instance, an $80-plus a barrel be the new normal for oilRs Will worries about the US’s wayward fiscal path trump the short-term rise in interest ratesRs Or, will its asset markets keep sucking money out of other asset classesRs

    There is precious little RBI can do despite its large tranche of reserves to ‘fix’ a fair value of the rupee if these global factors push it in a certain direction. I’m betting on the fact that oil prices will pull and longterm concerns about the sustainability of the US growth engine will make a return. The rupee, as a result, will move back to $66-67. But I’m clearly in a minority here.

    The writer is Chief Economist, HDFC Bank



    (Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
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    (What's moving Sensex and Nifty Track latest market news, stock tips and expert advice, on ETMarkets. Also, ETMarkets.com is now on Telegram. For fastest news alerts on financial markets, investment strategies and stocks alerts, subscribe to our Telegram feeds .)

    Download The Economic Times News App to get Daily Market Updates & Live Business News.

    Subscribe to The Economic Times Prime and read the Economic Times ePaper Online.and Sensex Today.

    Top Trending Stocks: SBI Share Price, Axis Bank Share Price, HDFC Bank Share Price, Infosys Share Price, Wipro Share Price, NTPC Share Price

    ...more
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