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Currencies Economics – Markets – Strategy Indian rupee – still sensitive to downside in Indian equities USD/INR forecast, eop Latest Prev Close 42.7 40.4 2Q08 43.0 41.5 3Q08 43.0 40.5 4Q08 43.5 39.5 1Q09 42.5 40.5 2Q09 42.5 40.6 3Q09 42.0 40.3 4Q09 42.0 40.3 RBI repo rate forecast, eop Latest Prev Close 8.00 7.75 2Q08 8.00 7.75 3Q08 8.25 8.00 4Q08 8.25 8.25 1Q09 8.25 8.25 2Q09 8.25 8.25 3Q09 8.25 8.25 4Q09 8.25 8.25 Latest close on Jun 11 Prev close on Mar 12 The Indian rupee (INR) has transformed from being Asia’s top performing currency last year to become one of its worst currencies this year. As at Jun 9, the INR has depreciated 8.0% year-to-date against the USD, in contrast to the full-year gain of 12.3% posted in 2007. Like it or not, the improving fundamentals responsible for appreciating the INR in the past few years have weakened in 2008. The most conspicuous source of INR weakness this year came from capital outflows. For the first time since 1998, net investments by foreign financial investors or FIIs turned negative. In the first five months of 2008, net investments fell by INR118bn, after having doubled to USD809bn in 2007 from an average INR414bn in the previous three years. In this regard, we were correct to link the INR’s vulnerability to its weak stock market, one of this year’s worst performing bourses in Asia. Pressure on the INR should intensify if the Sensex falls further towards the level of the Dow Jones Industrial Average. The stock market’s weakness is consistent with headline GDP growth moderating back towards levels posted in 2005. One area of concern is industrial production, where growth has decelerated for four consecutive quarters to 5.7% YoY in 1Q08, after peaking at 12.5% in 1Q07. Another worry is the unabated rise in oil prices, which is pressurizing both the trade deficit and inflation. Having surged to 8.24% YoY on May 24 from 3.07% YoY on Oct 13, WPI inflation has scope to trend higher towards double-digit levels after the latest fuel price hikes in June. Inflation has scope to increase political uncertainties if the government’s communist allies decide to withdraw support ahead of the next general election due in May 2009. Meanwhile, costlier energy imports are likely to lead to another significant deterioarion in the trade deficit to USD90bn in calendar 2008 from USD71.3bn the previous year. That said, we still consider the INR to be a structurally sound currency over the medium-term. At USD310bn in Mar08, foreign reserves are more than sufficient to cover total external debt, which last stood at USD201bn in 4Q07. Foreign direct investments (FDI) have remained strong, and should help to cushion the foreign portfolio outflows. The INR has scope to consolidate in a broad range between 40 and 43 after it returned some gains chalked in the previous 1-2 years. That happened in 2005 during the last US rate hike cycle. On the policy front, the INR is caught between the twin goals of price stability and restoring competitiveness. Unlike 2005, we are mindful that the stock market is more vulnerable because of outflows, and will downgrade the INR if we see FDI weakening as well. INR has been sensitive to weak Indian stocks Benchmark stock indices, spot 25000 20000 15000 10000 5000 0 USD/INR (rhs) Sensex (lhs) 02 03 04 05 06 07 08 50 48 46 44 42 40 38 First time since 1998 that witnessed FII outflows Net inflows from FIIs, INR bn 900 800 700 600 500 400 300 200 100 0 -100 2008 is cumulative Jan-May data 97 98 99 00 01 02 03 04 05 06 07 08 40
Economics – Markets – Strategy Currencies Vietnam dong – bears emerge The VND is under pressure from persistent double-digit inflation and a sharply widened trade deficit. This is a far cry from the Aug 2007 to Mar 2008 period when Vietnam was touted as the latest Asian Tiger to follow the path of China and India. Between 2007 and 2008, the VND has transformed from being one of Asia’s more promising currency to become Asia’s most worrying exchange rate. Unlike 2006 and 2007, Vietnam stocks have been depreciating steadily since 4Q07. By early June, the stock market effectively wiped out all gains achieved during the bull run from Aug 2007 to Mar 2008. As at Jun 9, the Ho Chi Minh Stock Index fell to 379, its lowest level since Feb 2006. The deterioration in the merchandise trade deficit has become too large to ignore. The trade gap totaled USD14.4bn in the first five months of 2008, exceeding the full-year deficit of USD12.4bn (17.4% of GDP) posted in 2007. Of course, a large trade deficit does not necessarily imply a balance of payments crisis. Foreign direct investments (FDI) have also risen and matched the increase in the trade deficit. Cumulative FDI amounted to USD14.7bn in Jan-May 2008. Like India, a wider trade deficit did not translate directly into a similarly significant wider current account (CA) deficit in Vietnam over the past few years, thanks to an improving services balance and increases in net transfers. That said, the government has warned that the CA deficit could be as wide as 6.5% of GDP and we expect a figure closer to 15% of GDP. On a positive note, foreign reserves are still strong and likely to have exceeded total external debt in 2007. Nonetheless, there is little room for complacency. Since May, international ratings agencies have, one after the other, been downgrading the outlook for Vietnam’s debt ratings to negative. The government must rein in persistent double-digit inflation before it begins to impact investor confidence and lead to significant outflows. CPI inflation more-than-tripled to 25.2% YoY in May08 from 7.3% the same month a year ago. This had led to more labor strikes at foreign companies clamouring for higher wages to keep up with inflation. USD/VND forecast, eop Latest Prev Close 16621 -- 2Q08 16650 -- 3Q08 16740 -- 4Q08 16860 -- 1Q09 16990 -- 2Q09 17120 -- 3Q09 17250 -- 4Q09 17380 -- SBV prime rate forecast, eop Latest Prev Close 14.00 -- 2Q08 14.00 -- 3Q08 15.00 -- 4Q08 16.00 -- 1Q09 16.00 -- 2Q09 14.00 -- 3Q09 14.00 -- 4Q09 14.00 -- Latest close on Jun 11 Prev close on Mar 12 Overall, the rapid deterioration in both the trade deficit and inflation suggests an overheating economy. Tough measures will be needed to rein in credit expansion and fiscal spending, as well as reforms to strengthen financial institutions and capital markets. The VND will also need to depreciate to regain some of the competitiveness eroded by inflation, as well as to counter the deterioration in the trade sector. Hence, the government’s decision on Jun 10 to devalue the VND by 2% and hike interest rates to 14% from 12% should be viewed as the first steps in the right direction. VND finally succumbed to falling stocks 1200 1100 1000 900 800 700 600 500 400 300 Ho Chi Minh stock index (lhs) USD/VND (inverted, rhs) Jan-06 Jan-07 Jan-08 15800 15900 16000 16100 16200 16300 Not a balance of payments crisis yet USD bn 40 30 20 10 0 -10 -20 -30 -40 2008 is extrapolated from Jan-May data Foreign direct investment Current account Merchandise trade balance 01 02 03 04 05 06 07 08 41
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