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Takeaway: The Indian rupee may finally catch a bid in a way that is negative for Indian equities and INR-denominated fixed income (HINT: rate hikes).

SUMMARY BULLETS:

  • We believe future RBI Governor Dr. Raghuram Rajan will be more committed to arresting the rupee’s decline(s) to new all-time lows given that he helped architect a government push to combat rupee weakness largely through deregulation-induced FDI flows over the TTM.
  • No doubt, the new RBI leadership will have the same reservations about aggressively hiking rates as was consistently noted under Subbarao’s leadership: in the most recently reported quarter (1Q and 2Q, respectively), India’s real GDP growth came in at a full standard deviation below the trailing 3Y average; India’s benchmark WPI inflation reading came in at -2.3x standard deviations below its 3Y mean.  A blasphemous time to hike rates indeed…
  • Still it would appear to us that Indian policymakers are increasingly cognizant of the dangers to future growth posed by an increasingly-hawkish cost-push inflation outlook (via wholesale prices AND the cost of foreign debt capital). Thus, we think the probability of rate hikes in 2H13 is rising at an accelerating pace, which, if materialized, should continue to weigh on India’s beleaguered equity market (down -3.9% MoM vs. a regional median delta of +1.6%) and its local currency fixed income markets over the intermediate term.
  • All told, a counter-trend rebound in the rupee appears increasingly likely, though nothing sustainable enough to get excited about as a core long idea – especially in the context of our top-down #EmergingOutflows and #AsianContagion theses (email us if you'd like to get up to speed on either view).

 

DR. RAJAN TO THE [RUPEE'S] RESCUE?

Today it was announced that the current chief economic advisor to India’s Finance Ministry, Raghuram Rajan, will succeed Governor Duvvuri Subbarao atop the RBI when the latter steps down next month.

Dr. Rajan (MIT PhD), who is a former chief economist with the IMF and a former professor at the University of Chicago Booth School of Business, will no doubt further the Western academic economist bent at the RBI. That said, however, we do believe he will be more committed to arresting the rupee’s decline(s) to new all-time lows given that he helped architect a government push to combat pervasive rupee weakness (down -10.9% over the past 3M; 2nd worst among all EMs) largely through deregulation-induced FDI flows over the TTM.

WILL THE INDIAN RUPEE MEET ITS [NEW] MAKER? - 1

 

WILL THE INDIAN RUPEE MEET ITS [NEW] MAKER? - 2

To accomplish what are likely to be his stated goals on the currency front, Dr. Rajan must be committed to using the RBI’s monetary policy toolkit more aggressively than the outgoing Subbarao has been willing to do thus far. To date, the RBI has favored capital account tinkering in the form of regulating banks’ FX positions and current account tinkering in the form of gold import reductions – both in lieu of hiking interest rates.

In fact, the RBI has been on a clear easing bias since APR ’12, having lowered its benchmark repo rate a cumulative 175bps since then, with 75bps of the aforementioned sum coming in calendar 2013. We’d argue that their easy monetary policy, in large part, perpetuated India’s bloated current account deficit, which has recently widened to record levels and weighed on the rupee.

WILL THE INDIAN RUPEE MEET ITS [NEW] MAKER? - 3

 

WILL THE INDIAN RUPEE MEET ITS [NEW] MAKER? - 4

SHORT-TERM PAIN FOR LONG-TERM GAIN?

No doubt, the new RBI leadership will have the same reservations about aggressively hiking rates as was consistently noted under Subbarao’s leadership: in the most recently reported quarter (1Q and 2Q, respectively), India’s real GDP growth came in at a full standard deviation below the trailing 3Y average; India’s benchmark WPI inflation reading came in at -2.3x standard deviations below its 3Y mean.  A blasphemous time to hike rates indeed…

WILL THE INDIAN RUPEE MEET ITS [NEW] MAKER? - 5

Still it would appear to us that Indian policymakers are increasingly cognizant of the dangers to future growth posed by an increasingly-hawkish cost-push inflation outlook (via wholesale prices AND the cost of foreign debt capital). Thus, we think the probability of rate hikes in 2H13 is rising at an accelerating pace, which, if materialized, should continue to weigh on India’s beleaguered equity market (down -3.9% MoM vs. a regional median delta of +1.6%) and its local currency fixed income markets over the intermediate term.

WILL THE INDIAN RUPEE MEET ITS [NEW] MAKER? - 6

 

All told, a counter-trend rebound in the rupee appears increasingly likely, though nothing sustainable enough to get excited about as a core long idea – especially in the context of our top-down #EmergingOutflows and #AsianContagion theses (email us if you'd like to get up to speed on either view).

The reflexive interplay between growth, inflation, policy and macro market prices continues...

 

Darius Dale

Senior Analyst