The Indian rupee's (INR) fall is exclusively due to domestic factors. The Reserve Bank of India's (RBI's) action of tightening liquidity has taken up bond yields sharply higher with yields at the short end of the government bond yield curve rising by 400 bps (four percent) while long end yields are up by over 150 bps (1.5 percent). The rise in bond yields has led to fears of prolonged economic weakness and worries about banks' balance-sheets. The rise in bond yields has also led to fears of banks showing losses on their government bond holdings. The Bank Nifty has fallen by 32 percent since 15 July 2013.
On an absolute basis, interest rates in the economy are at levels where they can kill the economy. Money market securities' yields are at over 11 percent levels while five- and 10-year government bond yields are at levels of 9.5 percent to 9.25 percent respectively. Borrowing costs for government and the corporate sector are rising at a time when economic growth is running at a decade's low - this is almost fatal to economic growth prospects.
The only hope for the INR is interest rates coming off in the economy. The question is how will interest rates come off? The RBI can reverse its tightening policy but markets will be too worried on any reversal of steps to bring down bond yields. Banks will hold back any cut in lending rates as their nerves are shattered by the RBI's moves. Markets have absolutely no faith in the government taking the right decisions even if the government is actually trying to do the right things for the economy.
Market sentiments are frail at this point of time and any signs of optimism will be regarded as foolhardy. However, this is the right time to be optimistic as levels of the INR and bond yields reflect fear rather than fundamentals. Fear will take a while to die down but taking the right decisions in times of fear is what makes one successful.
The INR closed at all-time lows of Rs 63.13 against the US dollar today. It has fallen by over 5 percent since the RBI unleashed steps to curb INR volatility on 15 July. In the period from 15 July to date the Sensex and Nifty have fallen by 8.6 percent and 10 percent respectively and the 10-year bond yield has gone up by 165 bps (1.65 percent).
The INR fall is definitely not the result of global market volatility as the euro has strengthened against the USD by 2 percent while the US Dollar index that tracks the movement of the USD against a basket of major currencies is down 2 percent.
Emerging market currencies have seen mixed volatility with the Indonesian rupiah down 4.6 percent to the USD between 15 July and now. The Malaysian ringgit is down 2.8 percent while currencies such as the Thai baht, Korean won and and the Philippine peso are down by less than 1 percent. The Brazilian real that is down by 8.6 percent is the only currency that has depreciated more than the INR. Brazil, Indonesia and India have problems that are largely domestic in nature, leading to the severe underperformance.
The INR fall is not the result of worries over the US Federal Reserve (Fed) tapering off bond purchases starting September. US equities are marginally down since 15 July though US treasury yields have moved up by around 30 bps. US treasury yields are factoring in an uptick in the US economy and have risen by 140 bps from lows over the last couple of years.
The FIIs are blamed for the INR fall but their pace of selling is hardly anything to write home about with sales of USD 1.6 billion in debt and sales of around USD 1 billion in equities since 15 July. The FIIs had sold over USD 6 billion in debt from 1 May to 15 July 2013 and had bought USD 2.3 billion of equities in the same period.
Arjun Parthasarathy is the Editor of www.investorsareidiots.com a web site for investors.
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