Currencies – What next for the Indian and Pakistani rupee?

The Indian rupee has vindicated my bearish macro view in 2018 and is trading at 68.50 as I write. I believe the Indian rupee’s fundamentals and valuation still warrant a bearish view and a potential year-end target of 70.71. Why?

One, the Reserve Bank of India (RBI) has not intervened to defend a specific level or for the rupee nor is it prepared to aggressively raise rates to defend it. This tells me that the RBI is comfortable with the depreciation of the rupee, given King Dollar and the fall of the Chinese yuan to 6.7.

Two, India is the highest valued emerging market on the planet and I expect the exodus of offshore funds from Dalal Street’s debt and equity market to escalate for the rest of the year. This will continue to pressure the Indian rupee.

Three, 70% of the Indian current account is petroleum product imports and high oil prices could well mean the current account deficit rise to 2.5% of GDP, bad news for the rupee.

Four, tax collection post GST have not met the Indian government’s annual tax revenue targets. This is rupee negative as the BJP ramps up pre-election spending on rural payouts/welfare programs, thus guaranteeing a deterioration in the Indian budget deficit.

Five, the Indian government has widened its budget deficit targets from 3 to 3.3% at a time of exceptional US dollar strength, Washington’s global trade war and monetary tightening by the Federal Reserve. This means the yield on the ten year G-Sec note could well rise to 8.25%. This means selling pressure in the Indian government bond market, even though the yield on the benchmark ten year G-Sec note has risen 140 basis points since early 2017. A rise in the budget deficit to 3.5% of GDP is all too possible if the BJP pump priming is too draconian.

Five, the Indian rupee is still overvalued relative to its real effective exchange rates by the least 5%. This is all the more true since the depreciation of the Chinese yuan has amplified selling pressure on all Asian currencies against King Dollar. Adjusted for inflation, the REER suggests a 70 spot rate for the Indian rupee. This fact could explain the laissez faire, nonintervention policy of Dr. Patel’s RBI in the last two months.

Six, India’s political outlook will get problematic for foreign investors as Modi faces elections in key states such as Rajasthan (a swing state where it is probably sayonara for Chief Minister Raje) and Madhya Pradesh. This will sour foreign sentiment to hold rupee assets even though I believe the BJP will win the next election – but then I was sure about a Remain with in the UK referendum and a Hilary win in the US.

The Pakistani rupee is trading at 122 as I write. The State Bank of Pakistan’s foreign exchange reserves have plunged to a mere $9 billion or only two month import cover. Pakistan has no longer any credible probability of avoiding a new IMF program, which will only take place after an elected government is in place after the July 25 election. The caretaker Finance Minister Shamshad Akhtar said “market forces” will determine he rupee exchange rate, an ominous signal that the State Bank will allow the rupee to depreciate despite three successive devaluations since March. In retrospect, the PML (Nawaz) government’s policy of a de facto rupee peg at 105 enabled the Pakistani elite to squirrel billions of dollars abroad via an overvalued rupee while buying “undervalued” luxury imports. This is a typical Third World reverse Robin Hood (the rich steel from the poor!) I learnt while an undergrad while visiting Mexico during the traumatic Lopez Portillo peso devaluation. It is impossible for me to predict the results of the Pakistani general election. The grapevine in Karachi financial circles suggests Imran Khan’s PTI will win 100 seats, thanks to their friends in the deep state. Yet if this was true, why is the turnover on the stock exchange a mere $30 million? The stock market seems to suggest that PMLN will be a formidable opponent in the Punjab as Shehbaz Sharif has a reputation for administrative competence. Imran Khan’s visceral anti-Americanism will also mean the Trump White House could appose an emergency IMF bailout.

The Pakistani rupee is the worst performing currency in Asia in 2018. The fear of a Chinese hard landing and the reality of higher US interest rates mean the Pakistani rupee will continue to depreciate in 2018, possibly down to an IMF mandated level of 132 – 136.