Friday, December 13, 2013

Will Fed’s QE taper talk topple Rupee again?

When U.S. Federal Reserve chairman Ben Bernanke spoke of reducing bond buying quantity (Presently Fed is buying $85 billion per month and the program is popularly known as QE, quantitative easing) first time in the month of May, markets were surprised and spooked.

U.S. Benchmark 10 year treasury yields jumped more than 100 basis points within a short duration, equity markets throughout the globe slumped, hot money from emerging markets started flowing out, developing countries’ currencies tanked and Indian Rupee was the worst performer of the league. Rupee touched historical all time low of about 69 per dollar in August from as high as 53 per dollar in May.

After continuous speculation in the markets, markets were prepared for QE tapering in September, but Fed took a cautious call not to taper and surprised markets again.

Following 2 successive months of Non Farm Payrolls jobs data around/above 200,000 and unemployment rate falling to 7%, there is again speculation of tapering in the markets. Timing and quantity of the tapering is a debatable question but will that talk of tapering cause volatility in forex markets again? Will Rupee again tank to such drastic level with such aggressive bearish bets.

I think, pace and level of volatility what we saw after Chairman Bernanke comments in May were too fast and too much and that may not repeat if tapering happens also. Obviously there will be some reversal in recent gains attained by Rupee as whenever U.S. sneezes rest of the world catches cold! So there may be slide in the level of Rupee but with not such aggressive pace and the level, seen earlier because of the following five reasons.

Priced in the market
Tapering news was new when Chairman Bernanke spoke about it in the month of May. After that various regional-Fed presidents either talked against it or in support of it. Markets participants started analysing for and against the tapering. Markets were prepared for tapering in September month’s Federal Reserve meeting itself. So this time whenever it happens or mere talk of tapering may not cause such drastic moves in Rupee markets as it is already priced in the markets that eventually tapering had to be done, it’s just a matter of time and quantity.

Bond yields
When Bernanke talked about it first time in May, Benchmark 10 year treasury yields were as low as 1.6% and now they are trading at 2.8%. Talking about Indian government 10 year bond yields, they were around 7.5% in May and now trading at around 9%. Both the countries yields are elevated levels indicating tighter liquidity scenario in coming months and looks like they are prepared for tapering.

Current account
Indian current account deficit (CAD), the difference between outflow and inflow of foreign exchange, was one of the worst among the emerging countries. But CAD reduced substantially over the last quarter. India's current account deficit narrowed sharply to $5.2 billion, or 1.2% of GDP, in the July-September quarter of 2013-14 on the back of turnaround in exports and decline in gold imports. Thanks to RBI and governments moves to curb the gold imports and improvement in exports helped by Rupee depreciation as well as recovery in global economy. The current account deficit was USD 21 billion, or 5 per cent of the GDP, in the second quarter of last fiscal. On Sequential basis also CAD improved from $26.9 billion in previous quarter.

Bottoming out of growth rate
India’s gross domestic production growth rate on decline from 2010 peak and it seems that it is bottoming out around 4.5% - 5% levels. GDP expanded 4.8% in the three months ended 30 September, compared with 4.4% in the preceding quarter. From last 4 quarters Indian GDP is hovering around 4.675% (4.8%, 4.4%, 4.8% 4.7% in reverse order) indicating the bottoming out of the Indian GDP growth rate.

Rajan effect
After Raghuram Rajan became RBI governor, markets showed confidence in his ability and credibility to curb the inflation, bond market reforms, clear communication with market participants and forward guidance. His strategy to attract Dollar deposits through FCNR route helped Rupee to regain some of the losses in the forex market. His shifting focus towards CPI inflation from WPI inflation is good for Indian economy in longer run, even though it may hurt in immediate future. After yesterday’s CPI inflation of around 11%, Rajan may increase repo rate by another 25 basis points in next week’s meeting, which indeed in turn helps Rupee as hot money will be chasing for high yields.

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