ANZ RESEARCH FX INSIGHT 6 May 2016 INR: WEAKNESS ’MAY’ BE HERE FOR A WHILE The INR is one of the worst performing currencies resulted in a surge in foreign inflows into the Indian in May, historically. equity market, helping to propel INR higher. FIGURE 2. INR’S MAY WEAKNESS IS CONSISTENT An unusual absence of auspicious wedding dates in May this year may not be sufficient to prevent 8 Rupee appreciates INR weakness from repeating. 6 against USD INR’s close correlation with the equity market 4 means it is vulnerable to signs of domestic 2 slowdown and any reassessment of US Fed rate 0 hikes. each each year -2 With the currency on the rich side, INR’s -4 diminishing positive reaction to rate cuts and slow -6 Rupee depreciates reform progress also pose risks to the currency, in INR % spot returns vs USD inMay against USD our view. -8 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 We maintain our year-end USD/INR forecast of 68.5. Sources: Bloomberg, ANZ Research In our view, the INR May effect is due to a tendency SELL IN MAY SEEMS TO APPLY TO INR for the highest number of auspicious wedding dates The INR is typically one of the weakest performing to fall within that month, which leads to a rise in gold currencies in May. Figure 1 shows the average FX demand and other associated spending (INR: Indian spot returns against the USD over the period 2000- weddings and the impact on Rupee, 9 May 2013). It 2015 for the G10 and Asian currencies. Not only does is perhaps no coincidence that we tend to see a peak the INR post the largest average spot loss at 1.3%, in gold import volumes occurring in April and May but it also depreciates with consistent regularity (see Figure 3). during May. FIGURE 3. INDIAN GOLD IMPORT VOLUMES BY FIGURE 1. INR IS HISTORICALLY THE WEAKEST MONTH (% OF CALENDAR YEAR TOTAL) CURRENCY IN MAY (2000-2015) 12 0.6 0.4 10 0.2 8 0.0 -0.2 6 -0.4 month -0.6 4 -0.8 -1.0 2 Share of gold import volumes by -1.2 % % spot change againstUSD inMay 0 -1.4 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec JPY INR IDR PHP SEK CHF THB EUR CNY GBP CAD MYR AUD VND NZD HKD NOK SGD TWD KRW Sources: Haver, Bloomberg, ANZ Research Sources: Bloomberg, ANZ Research However, the number of auspicious days (Vivah Since 2000, INR has weakened in 12 out of the last Shubh Muhurat) varies each year, and in 2016 we 16 years, which means historically there has been a have an unusual situation where there are no such 75% chance of it depreciating during May (see Figure days in May (see Figure 4). In fact, between May and 2). It normally takes some kind of major external October this year, there are no auspicious wedding event to prevent the rupee from weakening in May. days at all, suggesting there could be some pent-up For instance, the landslide election victory in May demand in the final two months of the year. 2014 by Narendra Modi’s BJP party resulted in a surge of foreign portfolio inflows which lifted Indian asset prices and resulted in the INR rallying. In 2009, a sharp rebound in global equity markets off the lows seen during the global financial crisis FX Insight / 6 May 2016 / 2 of 5 FIGURE 4. AUSPICIOUS INDIAN WEDDING DAYS BY Then there is the prospect for global market volatility MONTH (2016 COMPARED TO HISTORICAL AVERAGE) when the market starts to price in a resumption of 14 US Federal Reserve rate hikes. The rally in the 12 Sensex and the INR since February was driven mostly by delayed Fed rate hike expectations, which 10 can easily turn around. 8 Days FIGURE 6. INDIA PMI AND BUSINESS CYCLE 6 INDICATOR EASING 4 65 16 2 14 60 12 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 10 55 % y/y Average auspicious days in the month since 2000 8 Number of auspicious days in 2016 PMI 6 Sources: www.drikpanchang.com, ANZ Research 50 4 So could a lean wedding season in May this year 45 2 prevent INR weakness from repeating? Looking at 0 history, this may not be the case. In previous years 40 -2 when there had been very few auspicious wedding 07 08 09 10 11 12 13 14 15 16 days during May, we still saw a decline in the INR. PMI (LHS) Business cycle indicator (RHS) KEEP AN EYE ON THE EQUITY MARKET Sources: Haver, Bloomberg, ANZ Research INR’s fortunes have been closely tied to the local Our economists expect the RBI to remain on hold for equity market since 2015 (see Figure 5). Given the the rest of this year. However, even if a rate cut influence that foreign equity flows have on the INR, materialises, it may only have limited positive impact this is not that surprising. Hence, this suggests that on the INR, judging from its recent reaction. The 5 there will be added sensitivity of the INR to April rate cut gave little cheer to markets, with the underlying domestic growth prospects, not to currency actually falling 0.3%, the highest decline in mention general global market risk sentiment. the last five rate cuts starting January 2015 (see FIGURE 5. INR AND SENSEX MOVING IN LINE Figure 7). We note that the INR tends to respond positively to: a) in-between policy meeting rate cuts; 30000 61 and b) cuts of more than 25bps compared to an 29000 62 expected 25bps cut during a regular policy meeting. 63 28000 USD/INR (inverse) With the April CPI moderating to within the RBI’s 64 27000 implicit January 2017 target of 5% and the Indian 65 Met Department’s predictions of above-normal 26000 66 monsoon this year, markets are already pricing in 25000 67 another 25bps of cut in H2 2016. If the RBI chooses SENSEX SENSEX Index 24000 68 to act later this year, the effect on INR could well follow April’s example. 23000 69 22000 70 FIGURE 7. INR’S POSITIVE REACTION TO RATE CUTS Jan 15 Apr 15 Jul 15 Oct 15 Jan 16 Apr 16 HAS ITS LIMITS SENSEX (LHS) USD/INR (inverse, RHS) Sources: Bloomberg, ANZ Research Notwithstanding the solid headline GDP growth figure of 7.3% for Q4 2015, there are signs that activity is slowing down. The Business Cycle Indicator has been trending lower, and the most recent PMI unwound some of the recent increases (see Figure 6). Though a positive step towards medium term growth, the passage of the Insolvency and Bankruptcy Code in the Lower House or Lok Sabha on 5 May will have little immediate effect in alleviating some of the headwinds to growth from high non-performing loans in the banking system. Sources: Bloomberg, ANZ FX Insight / 6 May 2016 / 3 of 5 REFORMS COMING? Although this increases associated risks to volatility Another downside risk to the INR is the slow pace of or liquidity, it will likely be short-lived in our view. reforms. The second half of the Budget session of FIGURE 9. RBI’S PRDUENT POLICY IN DEALING WITH Parliament resumed on 25 April. Our economists are FCNR SWAPS DUE FOR MATURITY LATER IN 2016 hopeful that the GST Bill can clear the main hurdle in 40 2016 and get it passed by the Rajya Sabha (Upper 30 House of Parliament). But even then, they see its rollout as likely only in 2017 as half of the 29 state 20 assemblies need to ratify the bill for it to be fully functional. 10 USD bn The Modi government’s ability to push such big 0 reforms through will be important for investor -10 sentiment towards India. -20 EXTERNAL VULNERABILITIES HAVE Aug-2008 Feb-2010 Aug-2011 Feb-2013 Aug-2014 Feb-2016 DIMINISHED Net forward book One thing we should not lose sight of is the fact that Sources: Bloomberg, ANZ India’s fundamentals have improved in recent years. The trade deficit has narrowed on the back of the fall BUT INR ON THE RICH SIDE in oil prices (see Figure 8), helping to reduce the Looking at various measures of INR’s real effective current account deficit from 5% of GDP in 2012 to exchange rate (REER), the currency remains richly 1.1% in 2015. Importantly, thanks to a pick-up in valued, though off its highs. An improved external net FDI, India now runs a basic balance surplus, position and bold reforms, if undertaken, could making it less vulnerable. In addition, the RBI has sustain the INR REER at current levels for longer. But built up its FX reserves and is in a good position to in our view, domestic prospects will not be strong smooth out volatility in the INR. Our estimate puts enough to prevent a further adjustment to the REER India as having the best reserve adequacy in towards its long-term average once the US Federal emerging Asia. Reserve resumes its policy normalisation. Hence, we FIGURE 8. IMPROVING TRADE BALANCE maintain our year-end USD/INR forecast at 68.5. 5 0 FIGURE 10. INR REER ABOVE THEIR LONG TERM AVERAGES 20 0 15 40 INR expensive -5 60 USD/bbl 10 -10 80 5 term average term USD bn - 100 -15 0 120 -20 140 -5 -25 160 -10 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 Trade balance (USD bn, LHS) Oil price adv 3 mths (USD/bbl, RHS, inverse) % deviation from long INR cheap -15 04 05 06 07 08 09 10 11 12 13 14 15 16 Sources: Bloomberg, ANZ BIS REER RBI 36 currency REER RBI 6 currency REER Another example of the RBI’s prudent policy is in building a substantial forwards buffer since 2014 to Sources: BIS, RBI, Bloomberg, ANZ Research curtail any currency risks arising from FCNR (foreign currency non-resident) deposits which are due to Khoon Goh mature between September and November 2016.