With Federal Reserve Chairman Ben Bernanke signaling an end to quantitative easing, investors are looking ahead to rising interest rates in the U.S.—and rethinking their willingness to tolerate risky emerging markets. As they do, India’s currency is taking a particularly painful beating. The rupee fell to a record low today, dropping the most in 21 months. Since April 1, the rupee has tumbled 9.2 percent, making it the worst-performing currency in Asia. The currency may continue weakening, with rupee three-month forwards dropping to 60.64 per dollar.
The rupee’s plunge comes at a particularly bad time for the government of Indian Prime Minister Manmohan Singh. The embattled leader is due to call elections by next year, and corruption scandals, sluggish growth, and persistent inflation have put the ruling Congress Party in a bind. To give the economy a lift before the voters go to the polls, Finance Minister Palaniappan Chidambaram wants the central bank to cut interest rates, but on June 17, the Reserve Bank of India left rates unchanged.
The currency’s slide adds to inflationary pressure in a country where the consumer inflation rate hit 9.31 percent in May. For countries with significant export industries, there are upsides to weak currencies, as exporters become more competitive in global markets. When it comes to exports, though, India is no China. India’s export sector is much smaller, so the weaker rupee won’t translate quickly into a significant boost for manufacturers that suddenly are more cost-competitive.
And by driving up the cost of imports, the weak rupee could exacerbate India’s double-deficit problem. The country has a worrisome gap in its trade and budget numbers, one reason the rating agencies have put Indian on notice for a possible downgrade. The current-account deficit was 6.7 percent of GDP in the last quarter of 2012. With the rupee so low, the cost of importing oil, gas, and coal will get more expensive, threatening to make the trade numbers much worse.
“The weakening of the rupee will make the current account deficit even higher, because India imports so much energy,” says Alicia Garcia-Herrero, chief economist for emerging markets at Banco Bilbao Vizcaya Argentaria (BBVA). That could put India in danger of a downgrade—and since the rating agencies have the country at the lowest possible investment-grade rating, India is just one downgrade away from perilous territory. “They are really at risk,” says Garcia-Herrero. “When you are one notch away, you can’t sleep easy. Either you are in huge portfolios, or you’re not.”
The new isn’t all bad. Last week, Fitch revised its outlook from “negative” to “stable,” citing confidence the government can reduce its budget deficit. And India’s IT outsourcing companies might gain an advantage from the currency’s weakness, since most of their customers are dollar-paying companies overseas, but most of their employees are rupee-earning workers at home. Of the 16 companies that Goldman says stand to benefit from rupee depreciation, seven of them are IT companies: HCL Technoloties (HCLT:IN), Infosys (INFY), Mphasis (MPHL:IN), Satyam Computer Services (SCS:IN), Tata Consultancy Services (TCS:IN), Tech Mahindra (TECHM:IN), and Wipro (WPRO:IN) all have significant foreign revenue and therefore may gain because of the weakness of the Indian currency.