Over the last two quarters, Indian companies have had it tough. Inflation shot up from 5.4 per cent in the first week of October 2006 to 6.09 per cent in the first week of April. The prime lending rate went up from 11.50 per cent to 12.50 per cent over the same period. Now, the rupee is hardening against the dollar. What does it mean for the stock investor?
The exchange rate problem. Since October 2006, the rupee has gained around 10 per cent on the back of large inflows into the capital account. Mukul G. Asher, professor, State University of Singapore, explains: "Asian countries such as China are not allowing their currencies to adjust (against the dollar) and creating negative externalities for others like India."
That is, these countries are keeping their currencies weak, creating a trade deficit in the US. The dollar has been weakening against most major currencies. Over the last month alone, it lost about 4.50 per cent against the rupee. This has helped companies importing raw materials or capital goods, but is likely to hit employment and growth in the long term.
This has also put the RBI in a spot. If it wants to keep the rupee weak, it will have to put rupees back into the economy to buy dollars. But that will offset some of the reduction in liquidity it had managed by raising the PLR and cash reserve ration.
So, on the face of it, rates will remain high, inflation could be checked a bit, but the rupee will continue to harden. Says Yes Bank chief economist Shubhada Rao: "If it (the shift) happens over the medium-to-long term, the fundamentals get time to adjust. We have seen a very sharp appreciation of the rupee over the past month due to higher capital inflows. In a growing economy like ours, we need exports to grow, but the hardening rupee can affect that."
Sectoral impact. The hardening rupee will hit some export heavy industries such as IT, pharmaceutical and textiles. But oil and gas as well as capital goods imports are expected to get a fillip. In general, experts say that large exporters with healthy margins will be able to absorb the low rupee realisation, but smaller companies with thinner margins will find it tougher.
The impact will be more marked for companies with thinner margins, typically, the smaller ones. The effect of the strengthening rupee was visible on the stockmarket. The BSE IT Index went down from 5,575.07 on 19 February to 4,672.56 on 2 April.
It rebounded after smart quarterly results from Infosys and TCS, but prices are still below their all-time highs. The margins of these companies could be further squeezed if the rupee continues to harden. Meanwhile, companies with high-end products with inelastic demand may remain unhurt by passing on the hit to the buyer.
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Sector swings IT, pharmaceutical and textiles, and gems and jewellery are likely to be adversely affected. Oil & gas as well as capital goods imports are expected to get a fillip. Government unlikely to let the rupee cross the 41 per dollar mark. Go for industries such as power, telecom and media as they earn most of their revenue in the domestic |
Outlook. In the short term, the hardening of the rupee would help fight inflation. But how far can the RBI and the government allow the rupee to appreciate? Abheek Barua, chief economist, ABN Amro Bank, says: "The rupee may climb to the level of 41 in the short term, but not beyond that because the RBI and the finance ministry will not like it to go beyond this level."
To check rupee appreciation, the RBI can take both monetary and non-monetary steps. RBI's recent monetary policy has abstained from monetary measures like hike in the CRR rate. Instead, non-monetary initiatives have been taken.
The overseas investment limit of Indian companies has been hiked, portfolio investment limit of listed Indian companies in listed overseas companies increased, ceiling on overseas investment by mutual funds enhanced, ceiling on prepayment of external commercial borrowings without prior RBI approval raised, and limit on permitted current or capital account transaction for individuals increased from $50,000 to $1,00,000 per financial year. The hope is that these steps will pull the rupee back to 43.00-43.50 to the dollar soon.
India's trade gap rose to seven per cent of the GDP in 2006-07 against the government's long-term target of 2.5-3 per cent, mainly because of the appreciating rupee. So the government will have to step in from time to time to check inflows in the capital account without keeping out the genuine investment needed to sustain growth.
As inflation subsides, the RBI, which is not able to buy dollars from the market now, can afford to buy dollars. Inflation showed some signs of abating in the last two weeks before it shot up again. Experts, however, say it will fall in the coming weeks as Rabi crops come into the market and the high base effect comes into play.
The strategy. Stay away from sectors that derive a bulk of their revenues from exports. Instead, go for industries such as power, telecom and media, which earn most of their revenues in the domestic market and are largely indifferent to exchange rate movements. While stocks of export-driven companies were struggling, Bharti Airtel gained around 12 per cent and Reliance Communication rose over 15 per cent in past one month.
Be cautious about investing in oil companies as the market has discounted the currency factor and the rupee may depreciate. Besides, global oil prices are holding around $65 per barrel. If the rupee remains high, hold oil marketing companies and sell sugar, cement and textiles.