India Intensifies War On Gold, Silver: Record Low Rupee Triggers Inflation

by: Moneyline

The Indian rupee fell by 0.5% to 61.5875 per U.S. dollar as of 9:51 a.m. today, to within 0.3% of a record low of 61.805 seen on August 6, 2013, while sovereign bonds declined today. There is widespread concern that measures to attract capital inflows won't be enough to stem the currency's slide as growth slows. India plans to curb some imports to rein in a record current account deficit, Finance Minister P. Chidambaram said in the parliament Monday. He also added that financial companies would be able to issue "quasi-sovereign" bonds to attract investment. The RBI - Reserve Bank of India will sell 110 billion rupees ($1.8 billion) of 34-day cash management bills today as it seeks to tighten cash supply to buoy the rupee. India's latest economic data and a renewed bid to pare a record current-account deficit that's spurred a rupee slide show stagflation conditions persist almost a year after the government started a drive to spur investment.

Higher Import Duty - Fresh Curbs on Gold, Silver and Crude Oil:

India had announced Monday plans to curb imports of gold, silver and some non-essential items, as well as demand for crude oil. The world's largest buyer of gold has yet again raised the tax on imports for a third time this year. Gold and platinum import duty stands increased to 10% from 8%, while the levy on silver was boosted to 10% from 6%, the Ministry of Finance said in a notification tabled in parliament Tuesday. India also increased the excise duty on refined gold and silver to 9% from 7% earlier. India had earlier increased taxes on bullion imports in January and June to tackle the current account shortfall. The central bank estimates the sustainable level for the deficit is 2.5% of GDP. Goldman Sachs Group Inc. predicts it will narrow to 4.2% of GDP in 2013-2014. The deficit, mainly fueled by imports of crude oil and bullion, is the biggest risk to the $1.9 trillion economy, according to the RBI. Gold imports by banks and other traders have come to a virtual standstill, while gold premiums and smuggling has increased multifold. For more on the same - Record Gold Premium, Demand, Inflation And Equities Twist = Higher Silver Prices. Gold consumption in India, which imports almost all the bullion it needs, accounted for 20% of global demand in 2012.

Finance Minister P. Chidambaram on Monday, told lawmakers that, "The RBI has taken a number of measures to increase the interest rate at the short end and this has contained the depreciation of the rupee to some extent. However, we believe that we have to do more to contain the current account deficit to reduce the volatility in the currency market and to stabilize the rupee."

The Indian government will also make another push for capital inflows, including allowing state-owned financial companies to issue "quasi-sovereign" bonds to finance long-term infrastructure investment. These measures besides changes in import duty structure could generate about $11 billion of inflows and keep the burgeoning current-account gap at $70 billion, or 3.7% of gross domestic product, in the current fiscal year.

Data shows Inflation and Economic Weakness:

The rupee's plunge to a record threatens to dash the Reserve Bank of India's hope that monsoon rains will boost farm output and help ease the fastest inflation among the world's largest emerging markets. The economic data this week showed the Indian economy struggling with falling industrial production and elevated inflation. Industrial production fell 2.2% in June from a year earlier after a revised 2.8% contraction the previous month, while consumer prices rose 9.64% year-on-year in July, government reports showed yesterday. India's inflation numbers compared with other emerging markets - 6.3% in Brazil, 6.5% in Russia and 2.7% in China. Governor Duvvuri Subbarao said July 30 the monsoon is a "silver lining" as the slumping rupee kept him from adding to three cuts in the benchmark repurchase rate this year. The agriculture ministry forecasts that the grain harvest may climb to a record. The July-September rainy season, the main source of irrigation for India's 235 million farmers, had its best start since 1994, according to the weather office. The RBI governor predicts India's CPI will quicken to 9.8% this month. Gains in wholesale prices, the RBI's benchmark inflation gauge, accelerated to 5% last month from 4.86% in June, according to a Bloomberg survey before data due tomorrow.

Another Bloomberg report Monday showed the goods trade deficit was $12.3 billion in July as exports rebounded and imports dipped. India's consumer inflation is the second fastest in the Group of 20 major economies, according to data compiled by Bloomberg. A gauge using wholesale prices probably quickened to a four-month high of 5% in July, the median estimate in a Bloomberg survey shows before an August 14 report. The yield on the 7.16% government bonds due May 2023 rose six basis points, or 0.06 percentage point, to 8.36%,according to prices from the central bank's trading system. Global funds have cut holdings of Indian notes by $9.9 billion since May 22, when Federal Reserve Chairman Ben S. Bernanke first signaled debt purchases may be tapered this year.

The current-account imbalance widened to an unprecedented 4.8% of GDP in 2012-2013. It has been 11 months since India began easing caps on foreign-direct investment and restrictions on the bond market to spur growth. "It shows you that the structural reforms that are necessary to bring about a sustained improvement in growth and sustained narrowing in the current-account deficit are not working fast enough," said Leif Eskesen, chief economist for India and Southeast Asia at HSBC Holdings Plc in Singapore. "This implies that the central bank will likely have to keep its currency stabilization measures in place for a while longer." India raised two interest rates last month to fight a slump of about 10% in the rupee versus the dollar in 2013 that risks fueling inflation." The growth and inflation indicators show that the economy is taking longer to come out of the stagflation-type environment and recent monetary tightening and uncertain global capital-market environment could mean weak growth for at least two more quarters.

Cash Reserve Ratio may need re-sizing

The cash reserve ratio, or the amount of cash lenders must deposit with the Reserve Bank of India, stands at a record low of 4%. Meanwhile, the statutory liquidity ratio, which includes securities such as government bonds, stands at 23%. RBI chief Duvvuri Subbarao said on Tuesday that "perhaps" there was a need to reduce the reserves that banks have to set aside via the cash reserve or the statutory liquidity ratios. The RBI has recently tightened monetary conditions by raising short-term interest rates and draining cash (read more on - Reserve Bank of India Aims to Drain Cash, Control Volatility And Support Rupee ) in a bid to defend the rupee, but the currency has weakened nonetheless, sparking concerns the central bank would need to either raise the CRR or raise the key repo rate. The RBI will sell 220 billion rupees ($3.6 billion) of cash-management bills each week, it said on August 8.

India and the Rupee seem caught in a Perfect Storm

India remains vulnerable to a current-account deficit on weak rupee. Global funds cut holdings of Indian debt by $8.4 billion since the start of June, worsening the currency's decline, on concern the U.S. will pare stimulus that fueled demand for emerging-market assets. Bond risk in India has risen. Government-controlled State Bank of India's credit-default swaps insuring the lenders' bonds against non-payment for five years have climbed 96 basis points from this year's low of 174 on May 17. The rupee is among five "fragile" emerging-market currencies partly due to relatively high inflation, according to Morgan Stanley. The Brazilian real, Indonesian rupiah, Turkish lira and the South African rand are the other four. India seems caught in a vicious circle in which severe balance of payments weaknesses, ineffective measures to shore up the tumbling rupee, a sharp decline in growth and persistent foreign outflows from its local currency debt market are all feeding on each other.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long in silver and also hold some gold.