With globalization comes the fear of economic contagion. The Indian economy has been no exception to this rule. The sovereign debt crisis in Europe and slow economic growth in the U.S. were some of the reasons that caused massive capital outflows from the Indian capital markets and caused downward pressure on the Indian Rupee (INR - Free Report) . The rationale behind this is that during periods of economic uncertainties, foreign investors generally withdraw money from risky emerging market investments and park them in substantially low risk assets. (Read Guide to Small Cap Emerging Market ETFs)
Of course, recent domestic reasons on the Indian front were also responsible for the dismal performance of the currency. The growth has been declining and the central bank does not have much flexibility on the monetary policy front due to high inflation. The GDP for the quarter ended March 2012 rose 5.3%, sharply down from 6.1% in the previous quarter. Recently the rating agency Standard and Poor (S&P) lowered its outlook from “stable” to “negative” on India’s sovereign rating along with 11 banks, despite the banks being adequately capitalized well above the regulatory norms. (read ETF Trading Report: Growth and Banking ETFs In Focus) (since any financial institution cannot be rated higher that the sovereign). This combination of external and domestic factors caused further downward pressure on the INR. (see Does Your Portfolio Need An India ETF?)
High fiscal deficit (5.9% of GDP) and increasing current account deficits (2.7% of GDP) are the main causes of worries for the Indian economy. Higher fuel and fertilizer subsidies and lower revenues in the form of taxes have worsened the fiscal deficit scenario. Moreover, increased imports of gold, crude oil and consumer goods coupled with a depreciating rupee also led to the widening of the current account deficit.
On the tax front, one of the major problems faced by the Indian government is tax evasion, both by domestic as well as foreign players. In order to grapple with this pressing problem the Finance Ministry of the Indian Govt. proposed to implement the General Anti Avoidance Rule (GAAR), thus trying to curb the avoidance of tax. However, the proposal seemed to have backfired. Due to lack of clarity on the GAAR, the Indian Capital markets witnessed heavy selling pressures from the FII’s resulting in underperformance of the INR relative to the USD. (see Bet Against the Dollar With These Three Currency ETFs)
The Reserve Bank of India (RBI) made a delayed intervention in order to prevent the INR from slumping further. Despite the rising inflation worries, RBI lowered the benchmark rate (Repo rate) by 50 basis points to 8% in order to improve the liquidity in the economy.
The RBI also asked the exporters to convert 50% of the USD held by them in the EEFC (Exchange Earners Foreign Currency) account to INR in order to artificially increase the demand for rupee and prevent it from sliding further. The Central Bank has resorted to selling USD in the open markets as well as implemented measures to curb speculation in the currency market by banks and other players in order to prevent the rupee from sliding further, but heavy foreign currency outflows on account of selling pressures due to global economic uncertainties seem to be taking its toll on the INR.
India’s foreign exchange reserves level is very impressive and as of December 2011, India was ranked 6th in terms of countries having the largest forex reserves. However, despite high level of reserves, the exchange rates remains vulnerable to foreign capital flows as the foreign exchange markets are pretty thin. (read India ETFs: Trouble On The Horizon?)
The INR exhibited a two way movement with a bullish trend until July 2011, reaching a peak of Rupees 43.94/USD on 27th July 2011. However, it started its depreciating trend post broader market slump in the U.S. The INR/USD breached crucial levels of Rupees 54.23/USD on 15th December 2011 and hit an all time low of Rupees 56.67 on 31st May 2012 after the announcement of a very weak GDP growth for 1Q12. Subsequently the rate has appreciated to about Rupees 55.50. At the current levels, the decline seems to be overdone and there are chances that the currency may appreciate slightly in the near-to-medium term from the current levels.
It is prudent to note that along with the INR some other major currencies such as Brazilian real, Mexican peso, Russian rouble, South Korean won and South African rand also plummeted versus the USD signifying increased demand for the safer USD in times of global economic uncertainity.
However, favorable demographic characteristics, growth potential, scope of diversification and supportive economic policies will make India an attractive destination for foreign investments whenever there is slight improvement in the global economic conditions.
The following exchange traded products cater to the investors seeking exposure in this segment.
Market Vectors Indian Rupee/USD ETN (INR - Free Report)
Launched in March of 2008, the Market Vectors Indian Rupee/USD is an Exchange traded note issued by Morgan Stanley that seeks to capture the essence of the S&P Indian Rupee Total Return Index. The index tracks the performance of the Rupee relative to the USD. The Index represents investments in three month non-deliverable forward contracts. The investments are cash settled after holding it till maturity and then rolled over into a new contract.
The product has $2.50 million in total assets and charges investors 55 basis points in fees and expenses. The product being an Exchange traded note, it will not have any tracking error as it does not incur buying and selling of securities. However, it is subject to credit risk of the issuer.
The senior debt credit rating of the issues stands at A+ and A2 by rating agencies Standard and Poor and Moody’s, respectively, but S&P has a negative outlook towards its long-term debt. The product has had a tough time in the last one year period given the fact that the rupee has significantly performed relative to the USD. The ENT has slumped -12.17% in the past one year period.
WisdomTree Dreyfus Indian Rupee (ICN - Free Report)
ICN invests in investment graded U.S money market securities and enters into similar size forward currency contracts or swaps against the INR, in order to provide investors the safety of the high credit rated U.S securities along with the comparatively high yielding Indian money market rates. The fund also captures the relative performance of the INR versus the USD.
The ETF has total assets of $17.96 million and charges investors 45 basis points as fees and expenses. Currently, the ETF has 6 holdings including 4 Treasury Bills, 1 repurchase agreement and 2 money market instruments. The fund has an average yield to maturity of 0.08%. The interest rate risk is minimal in this product as it targets the shorter end of the yield curve.
The average daily volume of the product stands at 10,260. However, due to the dismal performance on the INR versus the USD in the past one year period, ICN slumped -7.61%..