A Brighter Future for India

The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates.

It has over a decade since the term BRIC – the acronym for Brazil, Russia, India and China – was coined by Goldman Sachs in paper titled, "Building Better Global Economic BRICS." Goldman Sachs predicted that over the next half century these four economies would be wealthier than most of the current major economic powers. They appear to be well on the way. Over the past 10 years, these emerging economies have grown four-fold. China has become the second-largest economy while Brazil, India and Russia are among the 11 largest economies worldwide. According to the International Fund (IMF), their combined gross domestic product rose to $13.3 trillion last year from $2.8 trillion in 2002 as their share of the global economy increased to 19 percent from 8 percent.

The Hiccup

Despite their impressive growth pattern, the BRIC nations have stumbled recently. Concern about global growth and heightened European financial stress will add to the stress as these countries depend on exports as part of the economic engine. For the first time in 10 years, the Brazilian real, Russian ruble and India rupee have weakened the most of all the developing-nation currencies. The Chinese yuan, which was believed to be undervalued, has managed to depreciate more than in any other period since its 1994 devaluation began.Brazil's real lost 12 percent last quarter, the biggest drop among the most actively traded currencies tracked by Bloomberg. The depreciation in the Russian ruble and drop in the Indian rupee were almost twice the fall of the EUR against the USD in the same period. A number of signs point to the fact that investors are fleeing the BRIC emerging markets.  Brazil's consumer default rate rose to the highest level since 2009; prices for Russian oil exports fell to an 18-month low; India's budget deficit widened; and Chinese economy continues to slow.  Investors are bracing for more losses as economic growth slows.

Hard-hit India

There is no doubt the BRIC economic growth has slowed and investor's appetite for risk remains weak.  However, the Indian economy seems to have been hit the worst.  Asia's third-largest economy expanded just over five percent in the first quarter, the smallest growth in nine years, after a 6.1 percent growth in Q4 of 2011.  India's current account deficit widened to a record $22 billion in the same period.  The country's benchmark inflation rate was 7.55 percent this past May.  In addition, Fitch Ratings and Standard & Poor's lowered their outlooks for the sovereign debt rating to negative from stable in the past three months. India may become the first among the lead BRIC nations to lose its investment-grade credit ranking. Foreign investors only bought $7.4 billion of $11 billion available permits for acquiring local currency debt last month. In addition, global investors have cut bond holdings by $1.1 billion from a record $31.5 billion in February.  Meanwhile, the government projects unprecedented borrowing of $100 billion in 2012-2013 to fund its budget shortfall. Clearly, the demand for the Indian rupee (INR) has decreased.

The Future of INR

Since this time last year, INR has steadily weakened nearly 25 percent against the USD, and traded at a historic low near 57.50 per USD just this past June. Given that the European debt crisis has yet to fully pan out and the U.S. economy is sputtering, risk appetite should remain weak. Thus, the INR should remain on its historically weaker note for the near term. In addition, the widening current-account deficit means the rupee's direction will continue to depend on the supply and demand of the offshore financial market flows.

In an attempt to spur demand for their currency, the Reserve Bank of India said that certain manufacturing companies that earn foreign exchange income can borrow from overseas to repay INR loans for capital expenses. The central bank has set the ceiling for the facility is $10 billion. In addition, qualified foreign investors can now put money into mutual funds with at least 25 percent of their assets in the infrastructure sector. The Reserve Bank of India also announced it would increase the amount of government bonds foreign investors can purchase by $5 billion. Foreign institutional investors can now purchase $20 billion worth of government securities, up from $15 billion. The Reserve Bank of India said in a statement that "(L)ong-term overseas buyers such as sovereign wealth funds, central banks and pension funds will be allowed to invest in the debt directly to broaden the base of investors."

Given the current European debt crisis and investors' limited appetite for risk, I cannot rule out the possibility of another run-up in USD-INR in the near term, although I believe any such gains would be short-lived. The fundamental long-term outlook for India and its currency still remains bright. India will most likely outperform most Asian economies, only surpassed by China. The Indian GDP is still exceeding 5 percent. India's interest rates are among the highest in the emerging market countries and will contribute to attracting investors once the risk sentiment improves. The 10-year bond yields nearly 8.5 percent. I suspect the worst maybe over and any calming in global market should benefit the rupee. As a result, the INR trading at 50 to 55 per USD by this December is not out of the question.Bloomberg surveys various institutions (including Silicon Valley Bank) for their forecasted exchange rates over various time periods. Currently, Bloomberg's median forecasted rate for the end of 2012 has the INR trading near 52.50.