While most commentators are focused on current account deficit-CAD as a source of rupee weakness, over the short term, it’s the sales by FIIs in the debt market that is dragging the rupee down. That, in turn is influenced by the rising yield in US 10-year rate, fuelled by fears that Federal Reserve would start reducing its bond-buying based programme soon, which will push yields further up
The rupee has hit a record low of Rs61.80 to the dollar. The lowest intra-day low of Rs61.21 was earlier hit on 8 July 2013. The measures taken by the RBI to tighten liquidity has failed to yield any positive results. Though the government has taken a few steps to get foreign inflows, as seen in the past, these steps have failed to make an impact. Experts suggest that the government should focus on reducing the current account deficit (CAD). While a large CAD is responsible for the weaker rupee, the immediate cause is capital account, more specifically debt outflows caused by selling by the Foreign Institutional Investors (FIIs).
Over the past two months (June 2013 and July 2013), we have seen nearly Rs44,000 crore of foreign funds flowing out of the debt market. Outflows from equities have been comparatively lower at Rs16,400 crore. The rupee over these two months has depreciated by nearly 8% from Rs56.50/$ to Rs61.15/$.
For the week ended 2 August 2013, FII outflows from the debt market continued, pulling out Rs1,365 crore. The rupee which had begun strengthening declined by 3% from Rs58.91/$ to Rs60.80/$ over the week.
This the real reason for the immediate weakness in rupee which is in turn is leading to sales by FIIs in equity markets as well. What is the reason for so much of debt sales by FIIs?
The main reason is the rising yield of 10-year treasury bills of the US. Yields are rising because of fears that the Federal Reserve may start tapering its bond-buying programme of $85 billion a month. According to the data which was released on 31st July, the US private sector employment data improved and the economic growth in the second quarter grew at an annualised rate of 1.7%. This was better than that forecast by economists. The US private sector added 200,000 jobs, while economists forecasted a lower number at 183,000.
Foreign investors sold a massive Rs600 crore in the Indian debt market on the day US economic data was announced. The Fed Chairman Ben Bernanke had mentioned last month that the Fed will start pulling back on bond buying if the economy picks up.
This led to a sell-off in the US treasury market where yields rose as to a high of 2.706% after the data was announced, nearing its 23-month high of 2.756% touched on 8th July. US bond yields have increased sharply since the start of May. Yields have shot up by more than 100 basis points since the beginning of May, about the time the Fed hinted about its plan to reduce bond buying. Thirty-year bond yields reached 3.74%, the highest since 16 August 2011. On Friday, this trend broke with weaker-than-forecast report on U.S. job growth taking yields lower. US bond yields fell to 2.6%. But on Monday, an upbeat service industry report renewed anxiety that the Fed may begin tapering in September, taking yields up to 2.64% Disappointing economic reports due in early September, could push down bond yields again as the Fed may delay its tapering of bond purchases. The jobs data release will be the key data point before the central bank's next policy meeting in September. But there could be another round of sell-off taking yields higher, if the US economy shows signs of improvement.
For now, what is affecting India is the rising US yields, leading to selloff by FIIs of Indian debt, which in turn, has led to a weaker rupee, which affects equity sales by FIIs, resulting in further weakness of rupee. It is the case of the tail wagging of a dog-the tail of marginal capital outflows is wagging the dog of current account deficit to make the rupee weaker.
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