High CAD: The real culprit behind currency slide

Siddharth Tak/Rohit Joshi/ZRG

Indian Rupee has depreciated nearly five percent against the US dollar since the start of this calendar. The strength in dollar has not only impacted Indian rupee, but most of the emerging market currencies are weakening against it. Experts believe that global cues and high current account deficit are responsible for the currency slide.

The global cues are playing a big role in the exchange rate movements. The major reasons include: dollar appreciation backed with the improving outlook for US economy, pumping in a lot of liquidity by Bank of Japan (BOJ), interlinked global markets, rising attractiveness of US Treasury Bonds, and expectations of tapering of bond-buying program by the Federal Reserve.

Zee Research Group (ZRG) analysis reveals that amongst the BRICS (Brazil, Russia, India, China, and South Africa) member countries pack, barring China, all other currencies have depreciated since December 31, 2012. South Africa has witnessed the highest depreciation of 17.11 per cent in the value of its currency (South African Rand), followed by Indian Rupee (4.60 per cent), Russian Rouble (4.09 per cent), Brazilian Real (3.9 per cent).However, China Renminbi has seen an appreciation of 1.61 per cent in the corresponding period.

As per the analysis of the International Monetary Fund (IMF) Outlook published in April 2013, amongst the BRICS block, in 2012 South Africa’s current account balance stood highest at -6.26 per cent of its GDP closely followed by the Indian current account balance at -5.11 per cent of GDP. Even, Brazilian current account balance stood at -2.26 per cent. On the other hand, current account balance levels in Russia and China are comfortably poised at a surplus of 4.02 per cent and 2.59 per cent respectively.

The survey depicts South Africa’s poor situation on the current account balance front. Even India’s situation is not so promising as IMF data suggests that India is expected to cut down the current account deficit (CAD) by merely 0.17 per cent in 2013. Although RBI’s sustainable deficit level is between 2.5 and 3 per cent of the GDP yet India’s CAD touched a record high of 6.7 per cent in the October-December quarter of 2012-13 on the back of rising oil and gold imports.

In harmony with the IMF Survey, Madan Sabnavis, chief economist at CARE Ratings opined, “China being a major global exporter always has a current account surplus and hence they will never have a problem of currency depreciation. As far as other BRICS nations are concerned, they are dependent on foreign funds owing to high CAD and hence there has been a tendency for these currencies to get a beating.”

Sabnavis’ thought got an endorsement from DK Joshi, chief economist, CRISIL Research who averred, “Whichever country has a high CAD is more vulnerable to currency decline.”

Reiterating the view, Saugata Bhattacharya, chief economist at Axis Bank said, “If any economy is reeling under CAD and there is not enough capital flows then that currency will be hit harder than an economy like of Malaysia which has a current account surplus.”

Explaining the rationale behind the FII outflows from Indian Debt markets in the recent past, Sabnavis at CARE Ratings said, “There is a belief that the Federal Reserve would withdraw its bond-buying program before 2015, US interest rates likely to rise has led to negative sentiment. Consequently, investors have withdrawn money from these markets and even India has also witnessed withdrawal of funds from the debt segment.”

But there are others who reject the hypothesis that India is in a stressed situation. “Not really. CAD varies from country to country and the rupee should have depreciated earlier itself which didn’t take place. On the whole, what really happening is nothing unusual and it is more of a temporary phase and finally it will return to equilibrium. I don’t think India is in a desperate situation. Although we are growing at a lower growth rate pace yet fundamentals are strong,” added Sabnavis at CARE Ratings.

Referring to the policy response, Bhattacharya at Axis Bank said, “There are two things that one can do: Either you can take measures to reduce CAD or you can open up the economy to capital flows. The appropriate response is to take steps to reduce CAD. First being, the depreciation of currency will anyway help exports. Second being, try to use policy levers to make sure that the cost of imports goes up and try to reduce the level of aggregate demand within the system.”