No End in Sight for Sell-off in Indian Rupee

NEW YORK (TheStreet) -- Earlier in the month I suggested the Indian rupee was positioned for continued weakness. This has turned out to be the case, as the rupee continues to be one of the world's worst performing currencies -- hitting new record lows after declines of more than 17% for the year. The reasons for this have come from two central areas: market uncertainty generated by potential Syrian military conflicts has led to surging oil prices, and India's unmanageable current account deficit has discouraged investors from adding exposure in the country's assets.

The weakness has extended to India's stock and bond markets as well, and the situation is starting to more closely resemble the balance of payments crisis the country experienced in 1991 when India was forced to use gold as a collateral payment for covering import costs. India imports roughly 80% of its oil, and this month's 8.9% increase in Brent crude prices will only add to current account problems that have undermined prospects for the rupee all year.

In the first seven months of 2013, India imported oil at an average rate of $14.2 billion (a slight increase from the $13.9 billion in the previous year.) The government now plans to enact measures to reduce oil imports, but this is easier said than done and broader growth prospects are starting to look bleak. GDP figures for the second quarter are now expected to show an increase of 4.6%, and will likely drop below 4% for the year. If these estimates are accurate, capital flight and external deficits have created a scenario where India is expanding at its weakest pace since the 1991 crisis.

As a result, the rupee has seen some of its worst intraday declines in two decades, and the currency is now set on a clear path to fall below 70 against the U.S. dollar. The USD/INR forex pair has fallen by more than 13% this quarter but there is little to suggest that the declines have reached a bottom. In bond markets, yields for the benchmark 10-year note have surged to less than 9%, after seeing single-session gains of more than 50 basis points. In stocks, the SENSEX continues to trade under pressure, losing 7.4% on the year and falling to its lowest levels since September.

Central Bank Policy

At this stage, India's central bank will be forced to continue implementing new policy measures in order to avoid an all-out economic crisis. But widening deficits in India's budget and current account will likely push the rupee to new record lows before the end of the year. The Reserve Bank of India has defined its goals to contain its trade imbalances to $70 billion by the first quarter of 2014. The fiscal gap will be difficult to control, however, as plans to expand food programs (by spending 18.3 trillion in annual subsidies) create new obstacles in other areas of the economy.

All of these factors -- and the Reserve Bank of India's inability to sufficiently address key areas of concern -- suggest that this year's rout in India's stock and currency markets has yet to run its course. India remains particularly vulnerable to negative developments with respect to potential conflicts in Syria, and any external events that put upward pressure on oil and commodities prices. Credit-default swaps that insure debt incurred by the State Bank of India have risen by 111 basis points this month. This negative indicator of market sentiment suggests that India will continue to experience difficulties in attracting foreign investment -- an absolute necessity if the country hopes to rebalance its trade deficits. Until progress is made in these areas, expect the rupee to continue its slide and hit new record lows before the end of the year.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Richard Cox is based in China, and has lectured at several universities there on international trade and finance, focusing primarily on macroeconomics and price behavior in equity markets. His articles appear on a variety of Web sites, including MarketBulls.net, Seeking Alpha, FX Street and others. Investing strategies are based on technical and fundamental analysis of all the major asset classes (stock indices, currencies, and commodities). Trade ideas are generally based on time horizons of one to six months.

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