It appears the lazy cocktail party forecasts of 100 to the dollar may become ephemeral.
Significantly, thus far, global investors have been showing little interest in Indian debt.
I have learned from several decades of writing columns that it is quite exciting—from time to time—to put out a highly controversial headline, as today. But looking to the rupee’s recent performance and, critically, the increasing noise surrounding moves towards getting Indian government bonds incorporated into global bond indices, it is a question worth thinking about. The accompanying chart shows that over the last 400 trading days or so (since about June last year), the rupee’s lows have been rising—the lower line. To be sure, there have been occasional periods when this has happened in the past, but the rising tide has only been longer than today’s once before—in early 2009, when the rupee rallied for 600 trading days.
Which brings us to the upper line, and which—whether RBI actually uses this kind of chart or not—appears to represent RBI’s continuing efforts to protect export competitiveness and, incidentally, build reserves. Of course, this has an inflationary impact in terms of rupees released into the system due to dollar buying; RBI tries, of course, to limit this by sterilisation, but one way or another, rupees seep into the system exacerbating inflationary tendencies. Again, the limits of this process show up in RBI’s huge—reportedly, more than $50 billion—forward purchases which will have to be settled at maturity, merely deferring the liquidity flood.
Now, all this was fine when the economy was on its back and liquidity appeared to be the only oxygen the economy needed. As it happens, the economy has recovered quite nicely, at least in the organised sector and, of course, equity prices are rocking. At this point, however, inflation has become a real issue, both locally—talk to anyone who is less privileged than you—as well as globally. US inflation last month, at 6.1%, was at a 30-year high and the Fed (and other central banks) are standing by to tighten policy.
While this could push the rupee structurally lower, things could turn dramatically if we are able to enter the global bond markets. For a long time now, the government has been trying to globalise the Indian bond market, as this represents a huge source of capital for our growth; additionally, it would confirm our status as a global big boy. Significantly, thus far, global investors have been showing little interest in Indian debt—over the past decade, only about $40 billion has come in, amounting to just 2% of government debt. More recently, over the past two years, FPI investment in debt has actually been negative by more than $14 billion; over the same period, equity investment has been more than $36 billion positive so, clearly, it is not India’s current attractiveness (or the lack of it) that is keeping investors away.
The key issues were (1) the fact that the forward premiums were too high—or more correctly, the forward premiums are higher than the difference between Indian gilts rates and US treasuries—rendering any attempt to borrow in dollar and invest in rupee arbitrage-negative; (2) that real interest rates in India (yield minus inflation) were negative; and/or (3) structural, having to do with the ability to buy and sell off-shore, taxation, etc.
The government and RBI have been working actively with global index companies to address these structural issues and it is now expected that Indian gilts will be included in global indices by as early as the end of this year. There is a wide array of estimates of expected inflows ranging from $170-250 billion over the next 10 years; indeed, there are some ‘objective’ estimates that are looking for $40 billion to come in as soon as inclusion happens. Interestingly, on August 25 this year, there was huge bolus of nearly $1.5 billion that came into the debt market; this was a few days before RBI governor announced that “…global bond index inclusion should happen in the next few months…”—I guess ‘Chinese’ walls at bond houses are not as impermeable as believed.
This sort of huge and continuing increase in inflows will certainly upset RBI’s applecart, and its efforts to hold the line on the rupee without allowing inflation to explode will become increasingly difficult. In the short term, this upthrust may be counterbalanced by the strong dollar as the Fed wakes up to inflation, but bond index inclusion suggests we may be entering a brave new world of a stronger rupee and lower forward premiums in the medium term. Exports may suffer and, if they do fall out of bed, we could see sharp dips in the rupee punctuating the ride whenever the current account comes into focus. But it appears that the lazy (and increasingly infrequent) cocktail party forecasts of 100 to the dollar and, perhaps, even the dearly held 80 to the dollar (sorry Sandeep) may become ephemeral.
The author is CEO, Mecklai Financial
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