Further Fall of INR May Narrow Profit of Importers

New Delhi: As the rupee fell past 66.5/USD today, the concerns on the impact of currency depreciation have resurfaced as was the case in 1H13. However, India Ratings and Research (Ind-Ra) opines that the negative impact will be limited to highly leveraged net importers, some of whom because of their cost-structure exhibit a high sensitivity to ‘INR depreciation’.

According to Ind-Ra’s report Dollarization of Top 500 Listed Borrowers published on 16 July 2015, a 1% depreciation in the rupee value is expected to reduce the absolute EBIDTA of net importers by 0.19% (median). The negative sensitivity of the majority of Indian corporates to INR depreciation has shown a decreasing trend, since FY13. From the date of publication of the report (63.51/USD), the rupee has depreciated by about 4.5%. But even if depreciates by around 10% over the 16 July level to 70/USD, the median reduction in the absolute EBITDA for these largest net importers will be only 1.9%.

The agency remains cautious on the credit profile of corporates which are highly leveraged (net debt/EBITDA: 5.0x or more) and are highly sensitive to ‘INR depreciation’. These corporates are net importers and 1% rupee depreciation on a sustained basis may reduce their absolute EBITDA by 1% to well over 5%. Particularly affected would be highly leveraged corporates in the sectors fertilizer, consumer durable, chemicals, metals & mining and airlines. An INR rate of 68/USD to 70/USD on a sustained basis may reduce their absolute EBITDA by 10% to 30% over their FY15 levels.

The current pressure in the rupee may be attributable among other things to selling pressure on emerging market equities, in part triggered by the sell-off of Chinese equity by global investors. As such over the last 12 months, the correlation between incremental foreign institutional investor (FII) equity investment and equity returns of major Indian indices has been strong and is over 0.5. Likewise, the correlation between total FII investment (debt and equity) and INR strength has been even stronger and is above 0.7. Of course, arguably, both the currency strength and market returns may be attributable in part to the incremental improvement in the economy as perceived by market. However, it may also imply that in the event some FIIs sell-off Indian equities the rupee may come under pressure, even temporarily.

While given the commodity down-cycle and low level of capex activity, thereby reducing capital goods imports, India’s current deficit is firmly in check. In addition, India has a solid real interest rate (defined by World Bank as lending interest rate adjusted for inflation as measured by the GDP deflator). In FY14, India’s real interest was 6.2 % (FY13: 3.8%), according to World Bank. Given that lending rates have fallen by 30bp-70bp, while the measures of inflation have fallen at a much higher rate over the last one year, the agency estimates that the real interest rate have possibly increased further from 6.2%. Given some of the fundamental strengths of Indian currency, the agency does not expect the depreciation to be sustained even if the rupee depreciates further due to the purely tactical reason of an equity market sell-off.

The impact of currency depreciation on corporate margins, as indicated above, is purely due to rupee depreciation. The agency believes that currency volatility has a significant, negative impact on all corporates with foreign currency exposure which is difficult to quantify. To reproduce a paragraph from Ind-Ra’s report The Dollarisation of BSE 500 Corporates, 15 May 2014 “Heightened two-way currency volatility for a sustained period makes it difficult for corporates to take appropriate pricing or hedging decisions. Empirical observations tend to suggest asymmetric impact under such situations. Exporters make very limited gains (if any) while importers incur heavy losses. Hedging related losses often add to operation losses, worsening the impact”.