A Trade Deficit
India’s trade deficit reached a fifty-six month high in January this year. This was driven by a sharp rise in imports of petroleum, chemicals and machinery. Despite a 9% rise in exports at $24.3bn, a 26% increase in imports at $40.6bn outweighed any gains, leaving a trade gap of $16.3bn.
More widely, the Federation of Indian Export Organisations (FIEO) cited a short-term liquidity crunch as the primary reason for a slowdown in the exports of labour-intensive sectors such as garments, carpets and man-made textiles. This has been attributed to a delay in tax refunds since the introduction of the Goods and Services Tax.
Domestic Equity Markets
On Thursday 1 February the LTCG (Long-Term Capital Gain) tax on shares was announced in the 2018 Union Budget (10% tax over Rs 1 lakh). This is likely to have contributed to an investor sell-off, further hurting the rupee. The S&P BSE Sensex saw a decline of 800+ points following the news with shares in approximately 2,500 companies ending in red that week. This was compounded by foreign institutional investors pulling out almost $900m from equity markets since the PNB banking scam came to light on 14 February. Moreover, through the month of February, sentiment across Asian markets turned sour with Japan’s Nikkei seeing its biggest single-day drop since 1990. South Korea’s Kospi, the Shanghai Composite Index and Hong Kong’s Hang Seng also experienced significant single day falls.
But perhaps most significantly, global funds pulled $1bn+ from Indonesian bonds – a market and currency (the Rupiah) argued by many as a leading indicator for the Asian region in general (ex-Japan). This is because of the high foreign ownership of Indonesia’s bonds and its largely open economy, and typically thereby the first in the region to be sold when the long-term outlook weakens.
In mid-February India’s second largest state-owned lender, PNB, disclosed that it had detected a $1.77bn scam due to fraudulent ‘Letters of Undertaking’ (LoUs) being issued for securing buyer’s credit. The detection of the fraud had led to concerns that banks may become reluctant to roll-over buyer credit facilities using such instruments. This, in turn, led to stress in the system and a surge in demand for USD from importers who needed to repay the credit rather than roll it over. The offshore non-deliverable forwards (NDF’s) market reflected this with 12-month NDF’s trading close to 67.80 against USD.
USD Strengthening Internationally
A further dynamic adversely impacting the rupee’s fortunes includes the general trend of the USD strengthening internationally. Multiple factors are driving this. Firstly there has been an increase in demand for USD in the wake of the U.S administration’s recent measures to incentivise American companies to repatriate earnings from overseas.
Secondly, recent minutes from the Federal Open Market Committee (FOMC) suggested that the US Federal Reserve believes that there is substantial underlying economic momentum in the US economy which can withstand interest rate rises. This, coupled with the latest US jobs data and rising bond yields to multi-year highs, has fuelled inflation fears and a seemingly inevitable expectation of upcoming rate hikes.
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