Strategy To Outplay The Rupee Slide
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The worry of a rapidly declining rupee has been haunting us for quite some time now. We, at Dalal Street Investment Journal, have always kept a very close watch on this very critical factor, updating our readers from time to time on the course that the rupee is likely to take at least over the foreseeable future.
Just like the stock market, the movement of the currency reflects the happenings in the economy. While things did seem to improve from when we last covered the rupee’s movement, it seems to have been just a minor respite. In the last one year, the Indian rupee has depreciated by as much as 19 per cent. Now, it has gone downhill once again and rather sharply this time, breaching its all-time lows to hit a nadir.
The rupee has been the most underperforming currency in the last one year as compared to currencies like the Chinese Yuan, the Brazilian Real and the South African Rand. All these currencies have appreciated this year, thanks to the current account surpluses and the relatively steady economic fundamentals of these countries. India, on the other hand, has been facing pressures on all fronts. Economic growth has slowed down, inflationary pressures are just not ebbing, and to top this, government inaction on the policy reforms front has been hitting hard.
While the economy seems to be under pressure overall, the declining rupee is adding to the worries. Is this scenario likely to change any time soon? Well, we don’t think so. Here are some reasons why we feel that the rupee could continue to remain under pressure, at least for some time going into the future.
The Global Scenario
On the global front, there is nothing that points towards economic stability in the near future. The Euro zone problems just don’t seem to be getting over. Greece has long been holding off stability in the region. The problems there have once again reared their head, though expectations of the economy coming out of the woods are still alive. After France voted in Socialist Francois Hollande, who has promised economic growth and not austerity, there is now yet another major concern looming large on the European front.[PAGE BREAK]
What will now be closely watched are the elections in Greece. Presently, a pro-austerity coalition seems to be unlikely to come into power in Greece. Speculation is rife about the country’s possible exit from the 17-nation Euro zone, which could have a major economic fallout, not just in the European region but also globally. According to Dharmakirti Joshi, Chief Economist, CRISIL, “The election results in France and Greece are pointing towards the vulnerability of the union in the European zone. It is too difficult to be popular on the one hand and promote austerity on the other. The countries may not agree to the fiscal plans that the EU plans to roll out. This shows the challenges of keeping the EU together”.
The US too is facing its own set of problems. The economy is yet to pick up the momentum that is needed to bring the country out of the troubles it has recently faced. Elections are on the anvil in the US too. The overall geopolitical scenario that is panning out because of all of this is sure to keep the economic landscape volatile on the international front.
All these economic ups and downs have hit international trade, and India has not been an exception to it. This is reflected in the widening current account deficit (CAD), which stands for the excess of total import value over the total export value of the country. The CAD was at 4.3 per cent of the GDP at the end of the third quarter of FY12, considered to be the highest since the balance of payments crisis that we witnessed in 1991.
One of the factors contributing to such a huge deficit is the inelastic nature of our imports and the rising prices of commodities, chief among them being crude oil and gold. India happens to the largest importer of gold in the world, accounting for nearly one-third of the annual worldwide demand. This has led to the rise in the import bill of gold at a compounded rate of a little more than 26 per cent annually, from USD 4.1 billion in 2001-02 to USD 33.8 billion in 2010-11. Gold accounted for 9.6 per cent of the total import bill at the end of 2010-11, up from 8.1 per cent in 2001-02.
The true impact of the gold import bill on the CAD can be understood from the data presented in the table (Impact Of Gold Import On CAB). We can see that the country has witnessed a CAD in eight out of the past 11 years. However, not accounting for the gold import bill, the deficit turns out to be a surplus in five instances.
The government tried to contain this largely unproductive import by increasing the import duty on gold. However, this had to be rolled back in a short time. It seems that gold imports will continue to add pressure on the rupee indirectly.
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The Slide Impact
On one hand, companies with higher imports as a part of their costs are likely to face a tough time. On the other, there are sectors which have a high percentage of exports as their revenues, for which the depreciating rupee will be an added advantage. Pharmaceuticals, information technology, textiles, jewellery and automobiles are the few sectors that are likely to have a distinct advantage because of the falling rupee.
Loan Book Fears
The depreciating rupee is not only a clear threat to the import bill, but is also severely impacting the borrowing capacity of India Inc. Corporates had been increasingly tapping overseas loans until a few months ago, mostly in US dollars, to save costs arising out of higher interest rates and liquidity constraints within the country. However, the subsequent fall in rupee value has negated these benefits. In the last one year, the 19 per cent fall in the value of the rupee from nearly the Rs 44-levels against the US dollar to below Rs 53 currently, has increased the cost of repaying these foreign loans by a similar margin. This is also haunting to companies that have raised hefty amounts via the FCCB route in last few years. Now they have to repay that amount raised. FCCB to the tune of USD 2368 million are to get matured. The alarming fact is that 85 per cent of the companies who are likely to face FCCB maturity are trading at a discount to their conversion prices. This shows that either they have to refinance or pay back the amount. In both the cases it will severely impact their financials.
As per the latest data made available by the RBI, India’s external debt as at the end of March 2012 was placed at USD 370 billion, recording an increase of USD 63 billion or 3.4 per cent over the March 2011 levels, primarily on account of an increase in commercial borrowings, short-term trade credits and NRI deposits. The external commercial borrowings and short-term trade credits accounted for 70 per cent of the rise in total external debt over the quarter, broadly reflecting the surge in imports. NRI deposits and multilateral borrowings accounted for about 20 per cent of the increase in the total external debt. These are certain payments for which funds need to be kept in hand at all times.
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Fund Flow Impact
Since foreign fund flows have slowed without a proportionate slowing in imports, the pressure on the rupee is mounting. “With petrol and diesel prices managed artificially, there is little to expect on the inflationary front. If there is any revision in the fuel prices, we will see inflation going higher, and this will impact the economy in a negative way”, opines Hemal Doshi, Chief Currency Strategist at Geojit Comtrade.
A policy mess-up in the form of tax uncertainties robbed the advantages of record inflows in the first quarter, with net foreign institutional investors' asset purchases of Rs 43951 crore. Any measure by the RBI or the government could only be a temporary relief unless exports are raised substantially or imports are curbed. Doshi is also of the opinion that the current account deficit that is already at high levels and the inelastic nature of imports are impacting the health of the economy.
The Crude Impact
One of the biggest worries of a depreciating rupee has always been the impact it will have on our oil imports. Oil imports form the largest part of the forex payments. Crude, as a commodity, has stayed above the USD 100 mark for quite some time now, and a depreciated rupee will hurt our forex reserves, as more of it will now be needed to pay for crude.
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What You Should Be Doing
We, at Dalal Street Investment Journal, have always believed in facing challenges upfront. In this light, here are the options that can help you rather gain from the current scenario. We have selected companies with better foreign exchange earnings, and which have minimal or no exposure to foreign currency loans. Accordingly, we feel that HCL Technologies, Hindustan Zinc, Oracle Financial Services, Cadila Healthcare and Bajaj Auto are the stocks that one needs to latch on to in order to ride the depreciation wave smoothly and profitably.
Dhiraj Sachdev, Senior Vice President & Fund Manager at HSBC Asset Management, feels that sectors like pharmaceuticals and technology are preferred choices in the near term that may benefit from a depreciating rupee against the dollar. However, he is also of the opinion that for investment, apart from the currency benefit, one has to evaluate the demand environment, revenue model, growth sustainability and valuations with respect to specific companies within these sectors.
We are of the opinion that the fall in the rupee is not yet over, and there is still some more of a downside to be seen. Experts suggest that the rupee may test the 56-57 or even the 60 levels going ahead. Hence, we suggest that our readers should look into these stocks to work as a shield against the depreciating rupee. The following is a brief investment rationale for the stocks that we have selected for you.
HCL Technologies
What makes us recommend HCL Technologies to investors is that the company does not have any foreign currency loans on its balance sheet at present, which is likely to insulate it even in case the rupee continues its free fall. The earnings of the company in foreign exchange stand at around 65 per cent of the total revenues for FY11, after adjusting for the foreign exchange expenses. For Q3FY12 (it follows the June calendar), the topline has witnessed a growth of 27 per cent on a YoY basis, and stands at Rs 2164 crore. The bottomline too witnessed a good growth of 20 per cent on a YoY basis for Q3FY12, and stands at Rs 400 crore. On the valuations front, the company trades at a P/E of 19.92x. The stock is likely to be an ideal candidate for one’s portfolio.
Bajaj Auto
Bajaj Auto, the second largest two-wheeler manufacturing company, has much less exposure to the domestic two-wheeler segment than its other peers. With the expectation of exports remaining firm, the company is likely to perform better in the coming times. Its earnings in foreign exchange stand at around 23 per cent of the total revenues for FY11 after adjusting for the foreign exchange expenses, and this constitutes 27 per cent of the EBITDA. The company does not have any exposure to foreign currency debt in its books, which is an added advantage. For 9MFY12, the topline and bottomline has witnessed a growth of 27 per cent and 15 per cent on a YoY basis respectively, and stands at Rs 15107 crore and 2232 crore respectively. On the valuations front, the company trades at a P/E of 12.62x. The stock can be looked at for investing from a long-term perspective.[PAGE BREAK]
Hindustan Zinc
Hindustan Zinc is the third largest zinc producing company in the world that caters to six per cent of the total consumption. The foreign exchange earnings of the company stand at around 28 per cent of the total revenues for FY11, after adjusting for the foreign exchange expenses. The main demand for its products comes from China, the world’s largest consumer of the metal. The company can be looked at as a shelter to park your funds from a long-term perspective and if you want to play safe with the depreciating rupee. As of FY11, it does not have any exposure to foreign currency loans despite being in the capital intensive space. For FY12, the topline and bottomline has witnessed a growth of 14 per cent and 13 per cent on a YoY basis respectively, and stands at Rs 11405 crore and 5526 crore respectively. On the valuations front, the company trades at a P/E of 9.08x.
Oracle Financial Services Software
With 69 per cent earnings in foreign exchange, Oracle Financial Services Software is well placed to benefit from the incessant fall in the Indian currency. As of FY11, the company does not have any exposure to foreign currency loans even though it is in the capital intensive space. For FY12, the topline and bottomline has witnessed a growth of 10.39 per cent and 12.53 per cent on a YoY basis, and stands at Rs 2605 crore and 1089 crore respectively. On the valuations front, the company trades at a P/E of 19.23x. Moreover, as of FY11, the company has a surplus to the tune of Rs 4708 crore in its balance sheet. The company is primarily organised into two business segments, viz. product licenses and related activities (products) and IT solutions and consulting services (services). The product licenses and related activities segment deals with various banking software products. The stock can be looked at for investing from a long-term perspective.
Cadila Healthcare
Cadila Healthcare, one of the leading players in the pharmaceuticals space in India, is one the contenders likely to perform during these turbulent times and likely to benefit from the slide in the value of the rupee. Its foreign exchange earnings constitute 41 per cent of the topline. The company has a foreign currency loan to the tune of Rs 357 crore, but this gets negated if we consider its growth prospects going forward and the space it is operating in. For FY12, the topline and bottomline has witnessed a growth of 7.91 per cent and 4.40 per cent on a YoY basis, and stands at Rs 3150 crore and 637 crore respectively. On the valuations front, the company trades at a P/E of 25.65x. The results might look subdued, but its exports formulations were up 18 per cent. The US formulations sales were up by 26 per cent, mainly on account of the rupee depreciation and upsides from Zynesher Pharmaceuticals. The stock can be looked at for investing from a long-term perspective.