The Indian Rupee: New Risks Evolve As Oil Cools And Gold Imports Decline

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 |  Includes: ICN, INR
by: Sarita Pereira

Summary

Lower crude oil prices and reduced gold imports will reduce India's current account deficit, thus strengthening the Indian rupee.

Starting September 1, 2014, the Supreme Court will decide the fate of 218 coal blocks on a case by case basis. These blocks were allocated from 1993 to 2010.

Cancellation of these coal blocks would increase India's coal imports in the future. This will affect the current account deficit as well as investor sentiment.

The U.S dollar has been rising over the past few months as the U.S economy has been improving. A stronger dollar will weaken the Indian Rupee.

On August 18, 2014, Brent crude touched $101.11 a barrel, its lowest level since June last year. In H1 2014, the import restrictions drove Indian gold imports down by 77% to 150 tons compared to H1 2013. Last month, Indian gold imports declined 26.39% year-over-year (yoy) to $1.81 billion. Lower crude oil prices and decline in gold imports would reduce India's current account deficit (or CAD) and strengthen the Indian Rupee (or INR). The economic indicators are good but new risks have emerged in the last few days, which can affect the INR.

Coal block allocation verdict

India's coal imports will increase from 101 million tonnes (or MT) in FY 2011/12 (April 2011 to March 2012) to 266 MT in FY 2016/17 (April 2016 to March 2017) mainly due to the demand supply gap. Recently, the Supreme Court of India passed a verdict that declared the process of allocating 218 coal blocks to industrial groups between 1993 and 2010 as arbitrary and illegal. Nearly 33 coal blocks are operational with a capacity of 53 MT per annum. The Supreme Court will decide the fate of these allocations in a series of hearings that start from September 1, 2014. The Supreme Court could impose penalty or cancel these coal blocks on a case by case basis. This verdict will also impact power sector loans worth $10-$12 billion.

RBI has foreign exchange reserves worth $319.39 billion. The trade deficit in July 2014 rose 4% month-over-month to $12.23 billion. The trade deficit for FY 2014/15 (April 2014 to March 2015) is expected to be $142 billion, 2.37% higher compared to FY 2013/14 (April 2013 to March 2014). The CAD for FY 2014/15 is expected to be $39 billion or 2% of GDP. If the Supreme Court cancels all the 218 coal blocks, then the associated power generation and steel making companies will have to import coal from abroad. This move will increase India's import bill by $3 billion.

Foreign Institutional Investors (FIIs) have invested $26 billion in the Indian debt and equity market since the beginning of 2014. FIIs expect that the new government will revive the Indian economy by taking bold reforms. In February 2012, the Supreme Court had cancelled all 122 2G spectrum licenses as it found illegalities in the allocation process. A similar verdict in coal block allocation could affect India's image as an investment destination and thus capital inflows from FIIs.

Strengthening of the U.S. dollar

Source: Bloomberg

The U.S. GDP grew 4.2% in Q2 2014 beating the estimate of 4%. The U.S economy is expected to grow 3% in the current quarter, and 3.1% in Q4 2014. Last month, the U.S. added 209,000 jobs taking the unemployment rate to 6.2%. Since February 2014, the U.S added 200,000 plus jobs per month, which is positive sign for the U.S economy. The hiring for 2014 is expected to average 204,000 per month. The U.S. dollar has been strengthening over the last few months on account of the positive economic data. Recently, the U.S. dollar index crossed 82 levels. The improvement of the U.S. economy will strengthen the U.S. dollar, which could lead to depreciation of the INR. However, it may not be as severe as it was last year when the INR touched a low of 68.85 against the dollar.

Conclusion

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Source: Yahoo Finance

Over the last 3 months, the INR has depreciated against the U.S. dollar in spite of huge capital inflows to the country. The Supreme Court's verdict could affect the capital inflows to India, while the strengthening of the U.S. dollar can weaken the INR. I expect the INR to touch 63 against the U.S. dollar by the end of 2014.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.