India Sliding From Bad To Worse

While Abe and Kuroda-san would be jubilant, the powers that be in India are none too happy at the 44% devaluation in their currency in the last 2 years (and 17% collapse in the last 3 months) as capital floods out of the once potential growth-engine of the world economy.

Accelerating in the last few days amid capital controls and gold importation bans, Taper-based carry unwinds appear to have exaggerated initial flows and driven the USD to over 63 Rupee (and all-time record low).

India's Sensex stock market is down 11% in the last 3 weeks to 11 month-lows (as fast money exits in a hurry) and the beleaguered bond market has imploded from a 7.1% yield in May for the 10Y to 9.25% now (its highest since 2001).

Food prices rose at 9.5% YoY (vegetable +47% YoY) and fuel at 11.3% YoY sparking grave concerns across the nation of social unrest and bringing back memories of the 1990s - when the government was forced to ask the IMF for a loan to rebuild foreign reserves. Current efforts at stemming the tide have done little to stall the liquidity withdrawal...


The country's banking system is also a concern (via WSJ):

Indian banks' loan books are already a problem. But they're going to weaken further.


At State Bank of India, the country's largest lender by assets, nonperforming loans jumped to 5.7% of the total at June 30 from 5% a year ago. At Punjab National Bank, bad loans jumped to 4.8% from 3.4% a year earlier.




and a pending rule change could force banks to record more bad loans.

As the economy slows:

India's slowing economy is the main problem. Overall growth slumped to a 10-year low of 5% in the fiscal year ended March 2013.

And is likely to stay slow as the RBI maintains its tight policy to arrest capital flows... (via BofAML)

The harsh reality is that markets will only get more nervous till import cover reverts to the 8-10 months critical for stability.


How much more can the RBI sell?


US$25bn, but every US Dollar will only breed further questions about the adequacy of FX reserves. Each FX crisis costs US$15-20bn.



There, thus, is just about enough to last one more bout of FX volatility. It will be recalled that we had estimated that the RBI can sell US$30bn at the beginning of the present round; since then, the RBI has sold about US$5bn. And why US$25bn? Because the import cover will dip then to 6 months, last seen in 1993!. FX reserves will also come off to just 1.5x of 1-year's short-term external debt, only barely higher than the Greenspan-Guidotti rule of 1x.


What more can the RBI do?


Issue NRI (Rupee-denominated) bonds (US$20bn) or sovereign (USD-denominated) bonds (US$5bn a year) to hold Rs58-62/USD; expectations are otherwise climbing to Rs65/USD. The present FX measures will likely add US$5bn to FX reserves.


How long can the July tightening last?


We see FY14 growth plummeting to 4.8% if the RBI persists with them into the busy October-March industrial season.


Our best case has the RBI reversing in August with tapering expectations pushed back to December. Given good rains, monetary easing can pull down lending rates by 50bp and push up FY14 growth to 5.8%.


Our worst case is that the RBI gets stuck with the July measures into the busy season as a US Dollar rally driven by tapering pressures the INR over Rs63/USD. Rising lending rates will then likely pull growth down even further.


Critically - as we note above - this is not about interest rates anymore but FX rates and reserve recouping and if the Fed tapers in September, things could escalate even more as liquidity washes out. Relying on the Jalan (governor of the RBI in 1998) solution of issuing quasi sovereign bonds (currency-capped USD-denominated debt) is a long-shot as the Fed's tapering has sucked global EM bond flows away from everywhere.