Understanding the Depreciation of the Rupee

Every country exports and imports for its survival. As long as this equation of imports versus exports is balanced, it is good for the nation but when imports become more than exports, the value of the currency starts declining. It means that the country needs more from other countries while it has little to offer to them. Indian goods are bought with Indian rupees. Hence if the demand for Indian goods falls, consequently the demand for Indian rupee also falls.

India has dual challenges. While the demand for Indian goods seems to be waning, due to export slippage, India continues to import crude(petrol/diesel) and other imports vital for the economy at high international commodity prices and an inelastic demand for gold and silver. Therefore the demand for the dollars continues to be high. This situation puts further pressure on the Indian rupee widening the current account deficit.

What is the immediate fallout of the rupee depreciation:-

1) The price of petrol has gone up substantially. Also the price of diesel and
    LPG could spike. When the price of fuel goes up, the cost of transportation
    goes up and when the cost of transportation goes up, the cost of goods  
    goes up and thus inflation goes up. As we have a current account deficit,
    rupee depreciation has an inflationary impact.
   
2) Companies which are dependent on raw material imports or have imported 
    components could see profitability and market capitalization take a
    beating. This is because its profitability may get hit by higher input costs.
   
3) Foreign travel is set to get costlier. One would have to keep more rupees 
    on hand to purchase dollars to fund foreign travel.

4) Studying in foreign universities may get costly. This is the same in the
    case of foreign travel; more rupees would be needed to fund foreign
    education.
   
5) Several electronic goods which depend on imports and royalty payouts may
    get more expensive.
   
6) NRIs and exporters would be happy and can be expected to remit more
    dollars as they would get a higher price. Companies like IT software,
    Pharma and BPO would gain from the dollars that they earn by providing
    goods and service abroad.
   
As seen above, devaluation of the rupee is inflationary in nature, as we are net importers. There is a need by the Government to devise policies and tools to stem the fall of the rupee.

In this context it is important to examine the tools (short term and long term) that may be available:-


1) Government can buy Indian Rupees from the foreign exchange market by
    selling its dollars. This would however reduce the foreign exchange
    reserves which are needed to fund our imports. Hence this is not a
    sustainable solution.
   
2) Government can mandate banks to increase their Cash Reserve Ratio and
    Statutory Liquidity Ratio which means banks would have to deposit more
    rupees with the Reserve Bank. Alternately the central banks can issue
    bonds for the public. By these measures the central bank would reduce the
    liquidity in the system and try and make the rupee dearer. However, these
    measures have the effect of increasing interest rates which hurts
    profitability of companies and thus adversely 

3) The Government can ask companies who have dollar accounts to bring in
    the dollars back into the country and convert them into rupee accounts.
    This would increase demand for the rupee which in turn would stem the
    slide of the rupee.
   
4) The Government can make it easier for companies to borrow in dollars from
    abroad. Companies would get more rupees for every dollar borrowed. This
    would help them finance their working capital requirements. If the rupee
    regains its strength over a period of time, the borrower could have to
    return lesser rupees. However, if the rupee further slides then business
    would be at a disadvantage. Hence businesses would take this route based
    on their outlook of the rupee.
   
5) The Government can attract NRI dollar deposits by offering attractive
    interest rates
   
6) Government can reschedule / delay in paying off its dollar debts with the
    hope that the rupee would regain strength subsequently.Thus at a later
    day lesser rupees would have to be coughed up to repay the debts.
   
7) The Government can increase the limit of FII investment in debt papers.
    This would certainly bring hot money seeking quick gains. Some flow of hot
    money would be useful.
   
8) Government can liberalize foreign investments in insurance, aviation and
    retail, infrastructure sector, agro-based businesses as well as may reduce
    subsidy from various sectors. This would be one of the better moves as it
    would bring in serious long term money from abroad.
   
9) The Government could frame policies to restrict the import of gold by
    raising custom duty and thereby making investment in gold less attractive.
   
10)The Government could action some long standing economic reforms to
     induce both domestic and international investments. This would help in
     increasing production and productivity of the economy. Higher production
     along with productivity would help in increasing supply of goods and
     services and thereby reduce inflation. This would be a better and
     sustainable method for tackling both the rupee crisis as well as inflation.
     Economic reforms would bring in “Foreign Direct Investment”. Economic
     growth can improve investor confidence and this ultimately bringing back a
     higher trajectory of GDP growth.
   
The depreciation of the rupee has an immediate impact on India in many ways, as discussed above. It is important to understand the macro-economic situation and the ways and means by which the Government can battle the challenges and try to steady the economy.
 
Source : Tata Mutual Fund

A bit more pain could mean serious gains - Interesting Study by Morgan Stanley

Whenever the P/B multiple drops below 3, the Sensex has gained an average 30% in the 12 months following, avers Morgan Stanley

Investors in the Indian stocks markets may still have some reason to cheer.

The Bombay Stock Exchange Sensitive Index, or Sensex, has fallen sharply in recent months, down almost seven per cent since April. However, according to Morgan Stanley, if the price-to-book value (P/B) of the Sensex goes below three, the index gives 30 per cent returns in the next 12 months. On Monay, the Sensex closed at a P/B multiple of 2.98.

In three of the past four occasions, when the Sensex P/B has gone below three, the average returns in the following 12 months have been 30 per cent. But there is a caveat in the report, too. With a little more pain, that is if the P/B ratio comes down another 15 per cent from current levels, the chances of the market giving positive returns will be higher, said the Wall Street-based firm.


P/B is the ratio of the company’s or index’s marketcapitalisation to its book value, which is the total assets excluding intangible assets and liabilities. For example, a P/B of two indicates investors are valuing the company at twice the value of its hard assets. A lower P/B indicates the stock is undervalued.

In other words, P/B reflects investor sentiment on the value of the stock to its actual accounted value

Vikas Khemani, president and head of wholesale capital markets at Edelweiss, said price-to-book is a good indicator for taking contrarian bets in a bear market. “It’s ideal to invest in the market if you believe the earning power of the book is going to improve. Otherwise, the market can continue to trade at a low P/B multiple for a long time,” he said.

At the peak of the bull market in January 2008, the P/B multiple of the Sensex was nearly seven. The global financial meltdown that followed saw the 30-share index crash 60 per cent from the 20,873 on January 14, 2008, to 8,509 in October 2008. After the crash, the P/B multiple for the Sensex had declined to under three for the first time on October 10, 2008. In the following 12 months, the index had delivered a whopping 58 per cent return.

Similarly, on two such earlier occasions, in June 1999 and May 2004, after the Sensex P/B multiple went below the three mark, the market had given good returns.

“Buying equities is proving to be painful but we believe that, unless the world spins into another crisis, it is difficult to imagine Indian equities will go substantially lower on a relative basis,” said Ridham Desai, managing director & head of India equity research, Morgan Stanley.

The report notes India’s relative valuation to the Asia-Pacific (ex-Japan) market, in dollar terms, is currently lower than what it was during the 2008 crisis. And, though the market is 85 per cent above its March 2009 levels on an absolute basis, when adjusted for the growth in book value, the market is up just 15 per cent.

The brokerage, however, warns that given the macro situation, corporate earnings could fall by eight to 10 per cent in the ongoing financial year. It also observes that market participants in the valuations could be pricing things wrongly on the macro front.

How to get your home loan rate lowered

When Delhi-based Mahendra Gupta opened the recent letter from the housing finance company, there was both good and bad news for him. The dismal bit of information was that the 20-year home loan he had been repaying since 2008 still had 22 years to go.

Despite four years of regular repayments, the loan tenure had been extended because of the rise in the home loan rate from 10.25% in 2008 to 13% now.

The good news was that Gupta's lender was ready to convert the loan to a lower rate if he paid a one-time conversion fee. He paid Rs 7,300 and got the interest rate lowered to 10.5%. "My loan tenure came down from 272 months to 166 months. It was a straight gain of almost nine years," gushes the 35-year-old.

Gupta can consider himself lucky. Not every lender offers its customers this option. Worse, very few keep their customers updated about changes in interest rates or how they impact their repayment schedules.

Most banks just go by the wording of the loan agreement, which says the lender can increase the rate and accordingly extend the repayment tenure. If the term cannot be extended, the bank raises the EMI  amount or asks the borrower to pay a lump sum.

Be a proactive borrower

You need to be proactive about your loan repayment and check the interest rate you are being charged. When the base rate was introduced, home loan customers thought they would get more transparent deals from their lenders.

However, many banks continue to discriminate between old and new customers, charging the existing ones a higher rate than that being offered to new borrowers.

If you are being charged a higher rate, ask your bank to convert it to the rate applicable to new borrowers.

Don't assume your bank will not listen to your request. A slowdown in growth and intense competition in the housing finance sector have pushed banks to the wall.

Home loan growth slowed down from 15% in 2010-11 to 12.1% in 2011-12.

More importantly, the RBI has abolished the prepayment penalty levied by banks and housing finance companies. So, shifting to another bank is not as costly as it used to be.

"The RBI move has boosted borrowers' ability to negotiate," says Kapil Narang, chief operating officer, Ameriprise India, a financial planning firm.

Banks are willing to negotiate, especially if the borrower has a good repayment history. If a bank refuses to budge, a mild threat of shifting the loan to another lender can work wonders.

"There are instances where banks have offered to cut rates when the clients expressed their intention to transfer the loan to another bank," says Vipul Patel, director, Home Loan Advisors, an independent mortgage consultancy firm.

 

 

Balance tenure is crucial

Keep the remaining term of your loan in mind when you sit at the negotiating table. When Gupta got his interest rate converted to 10.5% from the earlier 13%, his tenure of 22 years and 8 months was cut down by 8 years and 10 months. Remember that if your loan has less than 10 years to go, the benefit may not be as spectacular. As the table shows, the benefit progressively reduces if your balance tenure is lesser.

A 1.5 percentage point cut in the rate will shave off nearly five years from a 20-year loan, but it will reduce the tenure by just 1 month if the loan has only five years to go. Since you are paying a conversion fee upfront, the change may not lead to any significant gain. Go for it only if the reduction is at least 2 percentage points and your loan has more than 10 years to go.

 

 

 

 

Cut the tenure, not the EMI

When the interest rate on your loan is lowered, don't make the mistake of reducing the EMI. It's a tempting thought because it eases the pressure on your monthly budget.

However, lower EMIs mean longer tenures and higher interest costs. Instead, bring down the tenure of the loan. "Our standard advice is to avoid reducing the EMI amount. As far as possible, one should opt for cutting down the loan tenure," says Patel.

Only if you genuinely find it difficult to pay the EMI, should you opt for a lower instalment.

This is especially true of individuals who have taken a large home loan on the basis of a projected income, but have not got the kind of pay hikes they expected.

Also, double-income families, where one spouse has lost a job or stopped working, may find this option useful.

Besides, you should check if the new rate that is being offered to you is linked to the base rate of the bank. Make sure it is not a promotional rate that is being offered to new customers. Banks offer low rates to attract customers but hike the rate after 2-3 years. Since home loan tenures are typically 10-15 years, don't go by just the short-term benefit offered on the loan. The loan agreement should clearly specify the spread between this rate and the bank's base rate.

The cost of change

Don't think you can opt for a new and lesser interest rate for free. This conversion entails a minor cost, with banks charging 0.5-1.5% of the outstanding amount . It is also a fairly straightforward procedure, which can be completed with one visit to the bank branch.

 

However, switching to a new bank is a lot costlier and requires more paperwork. Even if your previous lender does not levy a prepayment penalty, the new lender will demand 0.5-1.5% as processing charges. There is also the convenience aspect. You will have to go through the entire process of submitting documents-proofs of income and identity, and PAN card, etc. Therefore, do a cost-benefit analysis before deciding to convert or switch to another lender.

 

Source : ET