Last week, I analyzed Asia
and assessed the health of its three largest economies — China, Japan and India. While China seemed fine and Japan was too early to say, I glazed over India without assessing the weakness story developing there.
Events of past few days have compelled me to dig deep into the events in India. As we all know, India has been producing weak growth numbers for the past several quarters. This weakness has been persistent and looks endemic now. With a bourgeoning current account deficit the biggest victim has been the Indian rupee. While the rupee has depreciated more than 20 percent in the last few months, I do not believe the fall is quite done yet.
The Reserve Bank of India intervened twice last month in an attempt to stem the fall. While it has not succeeded completely, the pace of the fall seemed to be holding, until this week. The Reserve Bank of India held interest rates steady, but reduced the growth forecast for the current year to 5.5 percent from 5.7 percent.
With creeping inflation, the ideal stance would have been to raise rates. To stimulate growth the Reserve Bank of India is sacrificing its inflation watch. As a result the rupee fell another 1.4 percent.
The fascinating story is the inverted yield curve. A traditional yield curve is upward sloping with rates higher as you go out longer. In this instance, the short-term rates have spiked to 11 percent, while the 2-year rate is around 8 percent. This indicates that the market believes gross domestic product (GDP) growth will normalize and interest rates will go down in the medium term. I believe this to be the fallacy of the market.
The current account deficit will not fall in the near term due to high import bills for oil. With weak growth projected for at least another year (there is an Indian election in 2014), there is no relief in sight. I project further pressure on the rupee and suspect it will fall another 10 percent.
Oddly enough, the only real savior of the rupee could be the lack of growth in the United States. With housing prices the only increasing indicator in the United States, I wonder how long the mirage of U.S. growth will persist.
If the upcoming U.S. GDP numbers are weak or show stagnation, we could start to see trouble brewing back home in the United States. An anemic jobs number this weekend may add further fuel to the fire. All of this could indicate a slower or no tapering by the Fed. If that scenario occurs, we may see a slowing down of the bloodletting in the Indian rupee.
While I do not have much faith in the U.S. economic growth story, I believe the data will somehow paint a decent picture. We will have jobs growth, but they may be low-paying or part-time jobs. We will see GDP growth, but since the government changed the way they calculate GPD it would be hard to trust it.
I recommend we short the Indian rupee. There are a couple of exchange-traded funds that track the Indian rupee. You can consider buying put options as you profit from the Indian governments incompetence.
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