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Mumbai: The Indian rupee traded at a lifetime low of 58.67 to the dollar on

Tuesday on continued dollar strength against emerging markets as well as major

global currencies. The domestic currency opened at 58.30 and rapidly

weakened. It closed at 58.14 per dollar on Monday.

The local currency is not alone in depreciating against the US greenback, but it

has lost the most value since the beginning of May among major emerging

market currencies except for the South African rand. That is attributable to Indias

own problems such as a high current account deficit.

Finance ministry officials played down the rupees movement, saying it was in

sync with other global currencies. There is nothing to panic, they said assuringly,

even as currency traders and experts remained divided on the rupees future

direction.

It looks like this weakness will continue for the next 10 -15 days, said Pradeep

Khanna, head of forex trading at Hong Kong and Shanghai Banking Corp Ltd

(HSBC). However, others are expecting the rupee to inch back from the present

level because of improved fundamentals.

We expect the rupee to come back because the fundamentals have improvedwith inflation lower, some foreign direct investment and improved fiscal situation.

If commodity prices come down, it will help the currency. However, the risk is that

the currency weakness will deteriorate the fundamentals, said Ananth Narayan,

regional head of fixed income, currencies and commodities in South Asia at

Standard Chartered Plc.

As the rupees direction remains unclear, heres a look at the impact of a sharp

depreciation on the economy and various sectors:

Trade and fiscal deficits

A weak currency might worsen the already-stressed trade deficit. The rupee is

not the only currency which is depreciating, so there is not much of an increase

in export competitiveness at a time when global recovery is still fragile.

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According toRupa Rege Nitsure, economist atBank of Baroda, in terms of the

real effective exchange rate (REER), a measure of a currencys strength against

that of its trading partners, the rupee has not depreciated much. Against our

(largest) trading partner US, we are about 9% overvalued, Nitsure said.

At the same time, however, a weak rupee will weigh on the import bill, worsening

the trade deficit.

Sonal Varma, economist at Nomura Financial Advisory and Securities (India) Pvt.

Ltd, estimates that a 2% REER depreciation of rupee will add 20 basis points

(bps) to the current account deficit (CAD) as a percentage of the gross domestic

product (GDP). A basis point is one-hundredth of a percentage point.

A falling rupee also makes oil imports costlier despite the international

benchmark Brent crude remaining stable for some time. A Rs.1 depreciation

increases the under-recovery (the losses on selling fuel below cost) bill

by Rs.8,000 crore. Assuming the government shares half of this bill, the fiscal

deficit increases by 4 bps, says Nomura.

Inflation, interest rate cuts

A fast falling rupee offset the benefits of lower commodity prices. In the case of

products such as fuel, a falling rupee straightaway translates into an increase in

the retail prices. In case of other products, the depreciating currency will increase

the price of imported raw materials. That impact on consumer prices will be seen

when the companies pass on the costs, which again depends on the demand

environment.

The imported inflation component will go up, said Varma of Nomura. If the

rupee depreciates by 10%, it will increase headline inflation by 1-2%.

This constrains the Reserve Bank of India (RBI) from cutting rates. If inflation

comes under pressure, rate cuts will be delayed. RBI mentioned in its annual

policy on 3 May that there was little space for further easing.

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According toSaugata Bhattacharya, economist atAxis Bank Ltd, the probability

of a rate cut by RBI is very low. He reasoned that if RBI cuts rates further, the

interest rate arbitrage (between Indian government bonds and US Treasury

yields) becomes less attractive, thus compromising the possibility of furthercapital flows.

To be sure, there are naysayers as well.

Keeping rates high will only defer recovery, deter FII (foreign institutional

investor) equity inflows and delay re-accumulation of FX (foreign exchange)

reserves, wroteIndranil Sengupta, economist atBank of America-Merrill Lynch,

in a note on Monday, predicting a rate cut soon.

Sengupta also quoted RBI governorD. Subbaraoin his defence: RBI governor

Subbarao called Indian exceptionalism in his speech at the London School of

Economics on 13 March (which said that) ... while debt flows may be more

sensitive to a narrowing of the interest rate differential, equity flows may actually

increase because they see in this a signal of lower inflation and better investment

environment....

And RBI may not intervene. The central bank has neither the intention nor thewherewithal to intervene in the foreign exchange market. Governor Subbarao on

Friday said the central bank is not targeting any rupee level but will come into the

picture only to smoothen volatility.

In India, RBI does not target any exchange rate. We intervene in the foreign

exchange market only to manage the volatility and to manage the disruption to

the macro-economic situation, Subbarao said on Friday in Hyderabad.

Moreover, India just does not have enough foreign exchange reserves to sell in

the market to support the rupee and thus intervention is meaningless. Since

2008, RBI has sold about $60 billion in the market to support the rupee, bringing

down the forex reserve to $287.9 billion, enough to cover imports for about six

monthsdangerously low, say economists.

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One good outcome of that inability to intervene is that it wont impact domestic

liquidity which has been in the deficit of over a Rs.1 trillion, on a daily average

basis, for the last one year.

Foreign investments

The rupees weakness may make foreign investors think twice before investing.

Foreign capital inflows are typically at risk when the local currency weakens.

Already, portfolio flows into both debt and equity have been gradually tapering,

with investors subscribing to the view that the local currency could depreciate

further.

The average daily net FII inflows into equities tumbled to $27.22 million in Junecompared with $171.4 million in May, according to data from the market

regulator, Securities and Exchange Board of India.

The speed at which it is depreciating, it is only rational that investors wait and

see where it holds, Ambareesh Baliga, managing partner, Edelweiss Global

Wealth, said in a phone interview. There is a pause for now as far as inflows are

concerned. If the rupee touches a new low and stabilizes there, foreigners may

then put in more money, as they would get more rupees for the same amount ofdollars they would have put in earlier.

The situation worsens in debt with FIIs pulling out $259.7 million in each session

in June compared with a $23.6 million average daily inflows the previous month.

The yield differential, between Indian 10-year government bonds and US

treasury yields of the same maturity, has fallen by 1 percentage point since the

beginning of this year.

Corporate profits

In a country dependent on imports for many raw materials, a weaker rupee

impacts the profits of companies at a time when they are already stressed.

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According toMadan Sabnavis, chief economist at rating firmCARE Ltd,

Corporate profitability would be affected negatively as the input cost will

increase for the companies that importing raw materials.

Interest payments

The interest burden would increase on foreign currency denominated debt. For

companies that have availed of foreign currency loans for implementation of

projects, the rupee depreciation will stretch heir balance sheets, as the amount of

debt will increase in rupee terms. As these loans mature, the cash flows will also

be impacted, said Pawan Agrawal, senior director at credit rating agencyCrisil

Ltd.

According to government statistics, out of Indias $376 billion outstanding

external debt, about 23% or $85.3 billion comprises external commercial

borrowings, or ECBs.

Software firms

As most Indian software firms derive upwards of half their revenue from the US,

a weaker rupee is good news for them. On average, a one percentage point

depreciation in the rupee translates into a 30-50 bps gain in operating margins

for information technology (IT) companies, according to analysts.

Ankita Somani, research analyst atAngel Broking Ltd, said, Most IT companies

currently have hedges at Rs.53-55 per dollar but now the rupee is at Rs.57-58 to

a dollar. If the average realized rate for the companies for the quarter is higher

than their hedging rate, then it would lead to a forex loss. Despite the forex loss,

companies would book a profit as operational gains would be even higher.

Pharma firms

The pharma sector will by and large benefit from the rupee slide as a majority in

the industry are net exporters. But the companies who have large foreign debts

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in the books stand to lose at this advantageous position due to heavy interest

burden, saidRajesh Desai, chief financial officer,Glenmark Pharmaceuticals Ltd.

Automobile industry

There is no single trend that can encapsulate the auto industry because of

varying levels of imports from countries as diverse as Germany and Japan. Still,

the weakening rupee and volatility of the same has put severe strain and

continues to be a concern forMercedes-BenzIndia. We are studying the

developments very closely, and if this trend continues, moving forward, we may

need to reconsider price re-positioning for specific models. We have not yet

decided a timeline for this, saidEberhard Kern, managing director and chief

executive at Mercedes Benz India Ltd.

Power sector

Struggling with a scarcity of coal, power firms are dependent on imports of the

fuel to keep their plants running. A depreciating rupee will dent margins either by

raising fuel costs or by making the economics of running the plant on imported

coal unviable. In an interview with Minton 30 May,Anil Sardana, managing

director ofTata Power Co. Ltd, lamented that despite drop in prices ofinternational coal, the company was unable to take advantage because of the

local currency weakening.

According toKameswara Rao, executive director and leader of energy, utility and

mining practice at audit and consultancy firmPricewaterhouseCoopersPvt. Ltd,

The drop in value of rupee byRs.1 against dollar has impact of around 5-6 paisa

on the variable cost ofpower generation utilities.

Aviation

A senior private airline executive, requesting anonymity, said the rupee

depreciation will significantly impact airlines as their dollar revenue is less while

most of their expenses are in dollars. Low-fare carriers that have less

international exposure in terms of flights will be adversely affected. Full service

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airlines will also be affected as they cant stay out of maintenance and repairs,

he said.

Krishna Merchant, P. R. Sanjai, Makarand Gadgil, Shally Seth Mohile, Ruchita

Saxena, CH Unnikrishnan, Zahra Khan, Ami Shah and Ravindra Sonavane

contributed to this story.

Pharma:

Most companies in the sector will gain from the rupee's fall, since a substantial

proportion of their revenues comes from exports. A strong US dollar and yen will boost

net sales and operating margins.

Gainers:

The major gainers will be Dr Reddy's Lab, Sun Pharma, Lupin, Glenmark, Wockhardt

and Cadilla Healthcare as they derive significant earnings from overseas markets.

Analysts reckon that with every Rs 1 movement, the earning per share of these

companies will change by 1-2%. For Cipla, which focuses mostly on the domestic

market, rupee's fall could be largely neutral. Aurobindo Pharma and Jubilant Lifescience

may not gain much since they have huge foreign borrowings of up to $600 million

(about Rs 3,600 crore).

Software:

The operating margins of software service exporters tend to go up by 30-35 bps when

the rupee falls by 1% against the US dollar. What may limit the positive impact of a

weak rupee on margins will be the strategy the companies adopt to pass on the benefitsto clients. Besides, the amount of foreign exchange hedging and the rate at which

receivables are sold in the currency forward market will also impact net profit.

Gainers:

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Front-end companies, such as TCS, Infosys, Wipro, and HCL Tech, may report

improved performance in rupee terms for the quarter to June. However, the impact on

net profits will be determined by the extent of hedging losses.

Telecom

Major telcos, including Bharti Airtel, Idea Cellular and Reliance Communications

(RCom), have substantial foreign currency debt on their books. The sharp fall in the

rupee in a short span against major hard currencies will expose these debt positions.

The impact on Bharti will be partially offset by its overseas revenue from the African

region. But, the company's net loss will get wider. Its debt-related currency exposure is

limited to borrowings of over $500 million (about Rs 3,000 crore) contracted in India, of

which 50% is hedged.

For Idea and RCom, external borrowings are 60-70% of their corresponding total debt.

Idea has hedged over half of this exposure, while the impact on RCom will be partially

offset by revenue from its overseas subsidiary Globalcom.

Automobiles

The automobile industry, which is a generous importer of auto components, could be hit

because of a fall in the rupee not only against the US dollar but also against other global

currencies, including the yen, euro and pound.

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The stress will be reflected in the financials of companies such as Maruti Suzuki, which

has a sizeable exposure to the Japanese currency, and also on Tata Motors to the

extent of foreign currency borrowings the company may have on its books.