Investor alarm as India flashes amber; RBI’s unexpected steps renew focus on Delhi’s troubled finances

July 23, 2013 3:22 pm

Investor alarm as India flashes amber

By James Crabtree in Mumbai

The rains fall fast during India’s annual monsoon season. Unfortunately for the country’s government, the rupee has fallen just as quickly. The Reserve Bank of India responded last week with a slate of measures to trim liquidity, aiming to stop further tumbles in a currency that has dipped around 10 per cent since May, hitting repeated all-time lows. The moves are also designed to win back badly needed foreign capital, which has flowed out of many emerging markets, including India, in the aftermath of remarks by US Federal Reserve chairman Ben Bernanke last month about scaling back the central bank’s asset-buying programme.Yet the situation in Asia’s third-largest economy is especially precarious, given the country’s large current account deficit. Rather than reassure investors, the RBI’s unexpected steps have only served to renew focus on India’s troubled finances and the uncertain outlook for its markets.

“The rationale behind these moves was a bit mystifying, and it did look as if someone panicked,” says Arvind Subramanian, an economist at the Peterson Institute for International Economics.

The measures, which analysts say were the equivalent of raising interest rates by around half a percentage point, succeeded in their most basic objective: the rupee has since held steady, below the symbolically important level of Rs60 to the dollar, closing flat at Rs59.70 on Tuesday.

But they did little to help India’s debt markets, sending bond yields sharply higher, or to stem the outflow of capital, $3bn of which has left the country during July, after strong inflows earlier in the year.

The impact on equity markets is more puzzling, however. The benchmark Sensex has performed strongly of late, rising by more than 8 per cent during the past month, even as the country’s economy has continued to weaken.

“India is seeing a bathtub shaped recovery, where the bottom of the bathtub just keeps getting more elongated,” says Manishi Raychaudhuri, head of equity strategy in emerging Asia at BNP Paribas Securities. “Given pedestrian growth and a depreciating currency you would expect the equity market to be much weaker than it is.”

Actions from India’s government provide part of the explanation, notably steps to liberalise foreign investment in the telecoms and defence sectors last week, and new curbs on gold imports on Monday.

But analysts also point to a more subtle response, as worried foreign investors focus increasingly on only the most highly rated stocks in especially resilient sectors, such as pharmaceuticals, consumer goods and IT outsourcing.

“The politicians [In India] are consistently of poor quality, but the companies, if you do your homework, are of decent quality. The problem is now one of price, not quality,” says Hugh Young, head of Aberdeen Asset Management Asia, a fund with roughly $10bn in Indian equities.

It was a pattern on show again on Monday, as shares in Hindustan Unilever and ITC, two consumer goods companies widely owned by foreign fund managers, hit all-time highs.

Other much-fancied companies are trading at vertiginous levels, notably Nestle India, another consumer group, which boasts a price-to-earnings ratio of more than 50, an indication of unusually high expectations of future earnings.

Yet even as investors grumble about over-valuation, India has one further advantage: the state of rival markets.

“If you compare it to the rest of the region, notably China or Korea, it doesn’t look that bad,” says Herald van der Linde, head of Asia-Pacific equity strategy for HSBC. “In terms of valuations, India doesn’t stand out as being extremely beautiful, but it stands out as being better than the others.”

Yet if equity investors are sanguine, economists are less so, pointing to major challenges ahead funding the current account deficit, at a time when politicians are distracted by the country’s upcoming national election, likely to be held next spring.

“Over the next six months there will be much greater pressure on the rupee, given the government either needs to attract $25bn of foreign capital at a time when capital is already leaving, or it needs to begin running down its reserves,” says the Peterson Institute’s Mr Subramanian.

Those reserves are in fairly good shape, with enough stashed away to cover at least six months of imports. But, even so, analysts at Bank of America Merrill Lynch said this week that the rupee could fall to Rs65 against the dollar next year, absent more radical moves to attract capital.

Such a level would put severe pressure on public finances, notably by raising the cost of subsidised fuel and fertiliser imports, while also pushing up inflation and raising new concerns for India’s many companies with unhedged foreign debt.

The RBI does have a number of possible further interventions, including a potential bond issue to attract money from Indians living abroad.

However, many analysts and investors worry that even this may not be enough to stem the rupee’s fall. “If I were a foreign speculator, I’d say the rupee is ripe for an attack,” Mr Subramanian says. “We are talking about an economy that is really flashing amber here.”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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