Inr: Weakness ’May’ Be Here for a While

ANZ RESEARCH FX INSIGHT 6 May 2016 INR: WEAKNESS ’MAY’ BE HERE FOR A WHILE resulted in a surge in foreign inflows into the Indian equity market, helping to propel INR higher. The INR is one of the worst performing currencies in May, historically. 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 INR weakness from repeating. 8 Rupee appreciates against USD 642INR’s close correlation with the equity market means it is vulnerable to signs of domestic slowdown and any reassessment of US Fed rate hikes. 0 -2 -4 With the currency on the rich side, INR’s diminishing positive reaction to rate cuts and slow reform progress also pose risks to the currency, in our view. -6 -8 Rupee depreciates against USD 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 for the highest number of auspicious wedding dates to fall within that month, which leads to a rise in gold demand and other associated spending <a href="/goto?url=https://anzlive.secure.force.com/servlet/servlet.FileDownload?file=00PD000000HVoeLMAT" target="_blank">(</a><a href="/goto?url=https://anzlive.secure.force.com/servlet/servlet.FileDownload?file=00PD000000HVoeLMAT" target="_blank">INR: Indian </a><a href="/goto?url=https://anzlive.secure.force.com/servlet/servlet.FileDownload?file=00PD000000HVoeLMAT" target="_blank">weddings and the impact on Rupee</a><a href="/goto?url=https://anzlive.secure.force.com/servlet/servlet.FileDownload?file=00PD000000HVoeLMAT" target="_blank">, </a>9 May 2013). It is perhaps no coincidence that we tend to see a peak in gold import volumes occurring in April and May (see Figure 3). SELL IN MAY SEEMS TO APPLY TO INR The INR is typically one of the weakest performing currencies in May. Figure 1 shows the average FX spot returns against the USD over the period 2000- 2015 for the G10 and Asian currencies. Not only does the INR post the largest average spot loss at 1.3%, but it also depreciates with consistent regularity during May. FIGURE 3. INDIAN GOLD IMPORT VOLUMES BY <ul style="display: flex;"><li style="flex:1">MONTH (% OF CALENDAR YEAR TOTAL) </li><li style="flex:1">FIGURE 1. INR IS HISTORICALLY THE WEAKEST </li></ul>CURRENCY IN MAY (2000-2015) 12 10 80.6 0.4 0.2 0.0 -0.2 -0.4 -0.6 -0.8 -1.0 -1.2 -1.4 6420 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Sources: Haver, Bloomberg, ANZ Research Sources: Bloomberg, ANZ Research However, the number of auspicious days (Vivah Shubh Muhurat) varies each year, and in 2016 we have an unusual situation where there are no such days in May (see Figure 4). In fact, between May and October this year, there are no auspicious wedding days at all, suggesting there could be some pent-up demand in the final two months of the year. Since 2000, INR has weakened in 12 out of the last 16 years, which means historically there has been a 75% chance of it depreciating during May (see Figure 2). It normally takes some kind of major external event to prevent the rupee from weakening in May. For instance, the landslide election victory in May 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 MONTH (2016 COMPARED TO HISTORICAL AVERAGE) Then there is the prospect for global market volatility when the market starts to price in a resumption of US Federal Reserve rate hikes. The rally in the Sensex and the INR since February was driven mostly by delayed Fed rate hike expectations, which can easily turn around. 14 12 10 8FIGURE 6. INDIA PMI AND BUSINESS CYCLE INDICATOR EASING 6465 60 55 50 45 40 16 14 12 10 820<ul style="display: flex;"><li style="flex:1">Jan Feb Mar Apr May Jun </li><li style="flex:1">Jul Aug Sep Oct Nov Dec </li></ul>Average auspicious days in the month since 2000 Number of auspicious days in 2016 6Sources: <a href="/goto?url=http://www.drikpanchang.com/" target="_blank">www.drikpanchang.com, </a>ANZ Research 4So could a lean wedding season in May this year prevent INR weakness from repeating? Looking at history, this may not be the case. In previous years when there had been very few auspicious wedding days during May, we still saw a decline in the INR. 20-2 <ul style="display: flex;"><li style="flex:1">07 </li><li style="flex:1">08 </li><li style="flex:1">09 </li><li style="flex:1">10 </li><li style="flex:1">11 </li><li style="flex:1">12 </li><li style="flex:1">13 </li><li style="flex:1">14 </li><li style="flex:1">15 </li><li style="flex:1">16 </li></ul><ul style="display: flex;"><li style="flex:1">PMI (LHS) </li><li style="flex:1">Business cycle indicator (RHS) </li></ul>KEEP AN EYE ON THE EQUITY MARKET Sources: Haver, Bloomberg, ANZ Research Our economists expect the RBI to remain on hold for the rest of this year. However, even if a rate cut materialises, it may only have limited positive impact on the INR, judging from its recent reaction. The 5 April rate cut gave little cheer to markets, with the currency actually falling 0.3%, the highest decline in the last five rate cuts starting January 2015 (see Figure 7). We note that the INR tends to respond positively to: a) in-between policy meeting rate cuts; and b) cuts of more than 25bps compared to an expected 25bps cut during a regular policy meeting. With the April CPI moderating to within the RBI’s implicit January 2017 target of 5% and the Indian Met Department’s predictions of above-normal monsoon this year, markets are already pricing in another 25bps of cut in H2 2016. If the RBI chooses to act later this year, the effect on INR could well follow April’s example. INR’s fortunes have been closely tied to the local equity market since 2015 (see Figure 5). Given the influence that foreign equity flows have on the INR, this is not that surprising. Hence, this suggests that there will be added sensitivity of the INR to underlying domestic growth prospects, not to mention general global market risk sentiment. FIGURE 5. INR AND SENSEX MOVING IN LINE 30000 29000 28000 27000 26000 25000 24000 23000 22000 61 62 63 64 65 66 67 68 69 70 FIGURE 7. INR’S POSITIVE REACTION TO RATE CUTS <ul style="display: flex;"><li style="flex:1">Jan 15 </li><li style="flex:1">Apr 15 </li><li style="flex:1">Jul 15 </li><li style="flex:1">Oct 15 </li><li style="flex:1">Jan 16 </li><li style="flex:1">Apr 16 </li></ul>HAS ITS LIMITS <ul style="display: flex;"><li style="flex:1">SENSEX (LHS) </li><li style="flex:1">USD/INR (inverse, RHS) </li></ul>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 or liquidity, it will likely be short-lived in our view. Another downside risk to the INR is the slow pace of reforms. The second half of the Budget session of Parliament resumed on 25 April. Our economists are hopeful that the GST Bill can clear the main hurdle in 2016 and get it passed by the Rajya Sabha (Upper House of Parliament). But even then, they see its rollout as likely only in 2017 as half of the 29 state assemblies need to ratify the bill for it to be fully functional. FIGURE 9. RBI’S PRDUENT POLICY IN DEALING WITH FCNR SWAPS DUE FOR MATURITY LATER IN 2016 40 30 20 10 0The Modi government’s ability to push such big reforms through will be important for investor sentiment towards India. -10 -20 Aug-2008 EXTERNAL VULNERABILITIES HAVE DIMINISHED <ul style="display: flex;"><li style="flex:1">Feb-2010 </li><li style="flex:1">Aug-2011 </li><li style="flex:1">Feb-2013 </li><li style="flex:1">Aug-2014 </li><li style="flex:1">Feb-2016 </li></ul>Net forward book One thing we should not lose sight of is the fact that India’s fundamentals have improved in recent years. The trade deficit has narrowed on the back of the fall in oil prices (see Figure 8), helping to reduce the current account deficit from 5% of GDP in 2012 to 1.1% in 2015. Importantly, thanks to a pick-up in net FDI, India now runs a basic balance surplus, making it less vulnerable. In addition, the RBI has built up its FX reserves and is in a good position to smooth out volatility in the INR. Our estimate puts India as having the best reserve adequacy in emerging Asia. Sources: Bloomberg, ANZ BUT INR ON THE RICH SIDE Looking at various measures of INR’s real effective exchange rate (REER), the currency remains richly valued, though off its highs. An improved external position and bold reforms, if undertaken, could sustain the INR REER at current levels for longer. But in our view, domestic prospects will not be strong enough to prevent a further adjustment to the REER towards its long-term average once the US Federal Reserve resumes its policy normalisation. Hence, we maintain our year-end USD/INR forecast at 68.5. FIGURE 8. IMPROVING TRADE BALANCE FIGURE 10. INR REER ABOVE THEIR LONG TERM AVERAGES <ul style="display: flex;"><li style="flex:1">5</li><li style="flex:1">0</li></ul>20 0 15 40 INR expensive -5 10 560 -10 -15 -20 -25 80 100 120 140 160 0-5 -10 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 INR cheap -15 Trade balance (USD bn, LHS) Oil price adv 3 mths (USD/bbl, RHS, inverse) <ul style="display: flex;"><li style="flex:1">04 </li><li style="flex:1">05 </li><li style="flex:1">06 </li><li style="flex:1">07 </li><li style="flex:1">08 </li><li style="flex:1">09 </li><li style="flex:1">10 </li><li style="flex:1">11 </li><li style="flex:1">12 </li><li style="flex:1">13 </li><li style="flex:1">14 </li><li style="flex:1">15 </li><li style="flex:1">16 </li></ul>Sources: Bloomberg, ANZ <ul style="display: flex;"><li style="flex:1">BIS REER </li><li style="flex:1">RBI 36 currency REER </li><li style="flex:1">RBI 6 currency REER </li></ul>Another example of the RBI’s prudent policy is in building a substantial forwards buffer since 2014 to curtail any currency risks arising from FCNR (foreign currency non-resident) deposits which are due to mature between September and November 2016. The RBI’s intervention in the forward book has sharply reduced after it ensured that it has the maturing FCNR swaps totalling USD32-34bn fully covered by its forwards purchases (see Figure 9). Sources: BIS, RBI, Bloomberg, ANZ Research Khoon Goh Senior FX Strategist <a href="mailto:[email protected]" target="_blank">[email protected] </a> +65 6681 8933 Rini Sen FX Strategist <a href="mailto:[email protected]" target="_blank">[email protected] </a> +91 8039527906 However, the RBI noted in it<a href="/goto?url=https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=36736" target="_blank">s </a><a href="/goto?url=https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=36736" target="_blank">press release </a>on 13 April that due to some maturity mismatch between the forwards and the maturing swaps, there could be “significant accretions initially to be followed by depletions of more or less similar magnitude” in reserves between September and November. <a href="/goto?url=http://twitter.com/ANZ_Research" target="_blank">Follow us on Twitter </a><a href="/goto?url=http://twitter.com/ANZ_Research" target="_blank">@ANZ_Research </a>IMPORTANT NOTICE The distribution of this document or streaming of this video broadcast (as applicable, “publication”) may be restricted by law in certain jurisdictions. 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Inr: Weakness ’May’ Be Here for a While

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