It’s not just the Indian importers who are a battered lot, thanks to the sharp depreciation of the rupee; foreign companies with large Indian operations are also very badly hit, as the Indian currency’s slide tells on their profitability in dollar terms. But equally, analysts are wondering whether the declining rupee – together with the reduction in oil prices – could mean that the current account deficit (CAD), the country’s external deficit before factoring in capital flows, has actually peaked and will now see a gradual decline by the end of FY13 (2012-13).
In fact, the rupee’s slide has two obvious sides to the coin. While, on the one hand, the fall has hit importing firms hard, the CAD could actually benefit from it. However, the bad news is staring in the face for foreign firms doing business in India. A Wall Street Journal analysis cites the examples of Standard Chartered, Unilever, HSBC Holdings, Vodafone Group and Japanese carmakers like Suzuki Motor, all of whom have substantial exposure in India, as being affected by the rupee’s rapid decline – 11 percent against the dollar in just three months. Companies which repatriate their earnings in dollars will find fewer dollars for the rupees they have earned.
But another analysis by Goldman Sachs’ chief economist Tushar Poddar, put out before the CAD figures came in on 29 July, reckoned that while CAD for FY12 would rise to a historic high of 4 percent against 2.7 percent in FY11, in a base case scenario, the figure could fall to 3.5 percent by FY13, thanks to the rupee’s slide and falling oil prices. While the rupee depreciation would make exports more competitive, the declining oil prices would make imports cheaper.
“Our analysis shows that the sharp depreciation of the rupee (INR) in real terms can help improve the trade balance significantly. Our estimates show that every 1 percent real depreciation in the INR leads to a 1.1 percent increase in exports with a lag of two months and a similar fall in imports after four months,” says Poddar in his report. The rupee is set to post its worst quarterly performance in 17 years.
Pointing out that the current account is highly sensitive to oil prices, the analysis estimates that every $10 fall in oil improves the current account by 0.4 percentage point (ppt) of GDP. “Thus, if oil prices were to remain at $90 per barrel in FY13, the CAD could fall to just 2.3 percent of GDP,” says Poddar.
While the CAD moderation theory may have people raising doubts based on falling demand from overseas markets, the Goldman Sachs analysis also points out that India’s export basket has around 60 percent of exports going to emerging markets, where the demand slowdown is not as sharp as that in developed markets. An improving CAD, in turn, will also provide the rupee with support, which Goldman expects to, in fact, appreciate over six months to a year.
But there’s a caveat too: “Risks to our view include a sharp increase in oil prices and a slower-than-expected recovery in export markets.”
Calling India’s rising CAD a “key vulnerability” for the economy, the Goldman Sachs analysis, however, says historical episodes of earlier significant rupee depreciation in real terms of more than 10 percent have led to sharp improvements of the trade balance.
“During the commodity-driven slowdown of 1995-1996, the INR depreciated by about 15 percent in real terms, and subsequently, the trade balance improved by 60 percent from trough to peak. During the Asian financial crisis of 1997-1998, the currency depreciated by 13 percent in real terms and there was a sharp improvement in the trade balance by nearly 50 percent. More recently, during the global financial crisis (GFC) of 2008, the currency witnessed a sharp depreciation of 18 percent, which was followed by an improvement in the trade balance of nearly 65 percent from peak to trough. These episodes were also accompanied by declines in domestic demand,” the analysis says.
Will FY13 be the year during which the runaway CAD will finally be checked because of the rupee-oil combination? Clearly, this will be one potent cocktail of factors.