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A Steady Decline

The Indian Rupee hit a new record low against the dollar this Monday. Falling to 61.21, the rupee was in keeping with the weakness it has suffered in recent times.

The rupee first slipped below the psychological barrier of 60 to the dollar on June 26. Since then, it has continued to slip, but for the occasional session gains. This is attributable to two major factors.

Key Reasons for the Fall

The first of these is the weakest economic growth that the country has experienced in a decade. In a report released this week, the International Monetary Fund (IMF) has lowered its projection for the country’s growth to 5.6% in the current financial year. This is marginally lower than its April estimate of 5.8%.

The second reason is the alarmingly high current account deficit of the country. The most representative measure of a nation’s international trade, it accounted for 4.8% of GDP in the last fiscal year.

In its report, the IMF has said that the tapering of the U.S. Federal Bank’s monetary stimulus could have serious implications for developing nations. The most immediate impact would be felt in the form of capital outflows.

A winding down of the bond purchase program is a direct result of positive economic data from the U.S. This would result in a flight of foreign capital. In June itself, $7 billion of portfolio funds have exited the country.

Differential Impact

A weaker rupee has a differential impact on various economic sectors. Imports become costlier, whereas exports become cheaper. Those companies which are heavily reliant on imports stand to lose the most. These include the likes of Tata Motors Ltd (TTM - Snapshot Report).

On the other hand, exporters, especially those from the outsourcing domain such as Infosys Ltd. (INFY - Analyst Report) and Wipro Ltd. (WIT - Snapshot Report) will gain from such an environment. They may be good additions to your portfolio.

Incidentally, Tata Motors has an expected earnings growth of 21% and the forward price-to-earnings ratios (P/E) for the current financial year (F1) is 7.28. Expected earnings growth for Infosys and Wipro are 13.4% and 11.5%. Their P/E (F1) are 3.02 and 15.93, respectively.  

Leading Indian banks will also feel the heat if the rupee continues to fall. These include the likes of HDFC Bank Ltd. (HDB - Analyst Report) and ICICI Bank Ltd. (IBN - Analyst Report). This is because a weak rupee would more or less rule out prospects of a rate cut.

Interest rates have been maintained at a low level to combat inflation, which has reduced somewhat only now. But a weaker dollar would result in higher oil prices, a key trigger for inflation, which is why the possibility of a rate cuts remains elusive.

Regulatory Action

The Reserve Bank of India (RBI) has now taken decisive measures to combat the situation. It has imposed restrictions on the derivatives market, focussing on currency derivatives. It has prohibited banks from trading in domestic currency futures and options. The Securities and Exchange Board of India has significantly increased the required margin to be maintained on dollar-rupee forward trades.

A significant amount of dollar demand is attributable to oil companies. The RBI has directed these companies to purchase their dollars from a single bank. It is believed that the fact that such companies were seeking more than one quote was adding to speculation and consequently, volatility.

Long-Term Measures

With elections around the corner, the Indian government can hardly afford to be complacent about the situation. Indian finance minister P. Chidambaram is currently visiting the U.S. to encourage companies to invest in India. These include the likes of Lockheed Martin Corp. (LMT - Analyst Report), The Boeing Co. (BA - Analyst Report), Microsoft Corp. (MSFT - Analyst Report) and Wal-Mart Stores Inc. (WMT - Analyst Report).

Of course, such investments can only come about only if India relaxes its FDI norms further. On the slate are plans to raise foreign stakes in supermarkets to 74%. Similarly, there is a proposal to raise the foreign investment in the defense sector to 49%.

In Conclusion

The current situation is symptomatic of a phase when developing economies need a fresh set of reforms. Though there may be some opposition to such measures, they will, in all probability, eventually go through.

And despite the current situation, India’s long-term prospects remain encouraging. This is equally true of its prominent companies, including those mentioned earlier. If you’re willing to weather short-term volatility, Indian stocks remain a good choice for the long term.

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