The rupee collapses – is it time to buy India?

published 20 August 2013

13-8-20-Bombay-SE — India's stock market has held up

Of all the Bric' economies (Brazil, Russia, India and China), I've always had a sneaking preference for India.

There's the fact that it's a democracy. Call me old-fashioned, but I still find that a desirable trait in a country. Democracy isn't everything Lord knows, India proves that but it does indicate a grasp of property rights that is lacking in both Russia and China.

Brazil of course is a democracy too. But I always liked the fact that India is one of the few emerging-market nations that isn't unlike Brazil heavily commodities-dependent.

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In any case, right now, the Brics don't have many fans at all. But India looks to be in the biggest trouble. The rupee keeps hitting fresh lows. We aren't seeing full-blown panic yet, but it could be a matter of time.

So is this a buying opportunity?

India's classic emerging-market dilemma

The rupee, reports the FT, started to "slide in earnest in May", triggered by Bernanke's warning. But the slide has turned into a rout. The currency has hit a series of new lows against the dollar, setting a fresh record this morning. It is down around 16% since the start of May.

Yet as James Mackintosh points out in his Short View column, that's still quite tame by currency crisis standards: "In 1997 the Thai baht more than halved in six months." So things could still get worse.

India has a classic emerging-market problem. The country runs a large current account deficit, at 4.8% of GDP. In short, that means it relies on foreign money to fund itself. This is fine when the foreign money wants to be there. It's not so good if this foreign money belongs to flighty investors, chasing the next big story. This so-called hot' money has a tendency to pack up and leave the instant things start to look tough.

One side effect of quantitative easing (QE) (in the early days certainly) was to push up the value of assets in emerging markets, as investors chased better returns. So there's a logic to the idea that the threat of QE tapering off, has driven money out of emerging markets.

And of course, there's a self-fulfilling aspect to all this. If investors fear that others will pull their money out of a country, then it's in their best interests to pull their money out first. A good rule of thumb in markets has always been: "if you're going to panic, panic quickly".

Competent governance can go a long way to soothing the fears of investors. If they think that the government has everything under control, and can fix a country's problems, then investors will be more inclined to stick around.

Unfortunately, India's governance doesn't encourage confidence. The government has introduced a range of measures to try to stabilise the currency. It has imposed capital controls not on foreign investors, but to prevent Indian companies and individuals from investing outside the country. It's also raised the import duty on gold Indians buy a lot of gold, and when they do, currency leaves the country.

But of course, these sorts of restrictive measures merely flag up how desperate a situation is. They also make foreign investors all the more keen to get their money out of the country in case the Indian government tries to trap it there, despite constant reassurances to the contrary.

The Indian stock market hasn't fallen far enough

So far, while the rupee has been hit hard, the Indian stock market has held up pretty well. Sure it's down about 10% this year so far, but it's hardly collapsed this is not yet a market in capitulation territory.

As the FT notes, foreign investors "own roughly half of freely traded Indian shares, but are yet to withdraw large quantities of capital." The danger is, these investors will be hurting quite badly just now. The market may be down 10% in local currency terms, but in US dollar terms, it's down about 20%.

So they'll be feeling jittery. They'll be hoping that things get better. But if it looks as though a big exodus from the stock market is on the horizon, they'll not want to wait in the queue to be the last to leave.

The Reserve Bank of India is getting a new central governor, Raghuram Rajan. Rajan is a smart guy with a good track record. He's one of the few economists in the mainstream who genuinely saw the financial crisis coming. And most of his peers still seem to think his ideas are a bit out there', which is a good sign, given how wrong they tend to be about everything.

The problem is, he has no good choices. India's problems are structural. As a central banker, he can only plaster over the cracks. If he wants to make the rupee stronger, the main tool he has is to tighten monetary policy. But that could make India's already frail economy slow down even further.

Perhaps more to the point, the real difficulty is that the one thing that affects Rajan's job most is completely out of his control. This panic was kicked off by fear of the taper' in the US. Chances are, if Bernanke changes his mind, or doesn't taper as early as markets expect, or by as much, then India and the other emerging market stocks will bounce back. But if the taper looks worse than expected, the sell-off will continue.

So while I like India and I'll be looking for an opportunity to buy in, I don't think we're there yet. I'd like to see a harder crash in the market, or a clearer sign that the rupee is out of the woods before I bought in. This is one to be patient on.

We'll be looking at emerging markets in more detail in the next issue of MoneyWeek, out on Friday. If you're not already a subscriber, subscribe to MoneyWeek magazine.

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.