Is the Indian Rupee headed for 50 to the US Dollar...again?

Now that I have got a few eyeballs (hopefully!!) with that headline, I hope to sustain the reading interest as well.

Not too much seems to be written about this topic nowadays. Or lets put it the other way, there are not too many bother points there. Newspaper/Magazine articles will generally follow only if there is an apparent problem caused by either more than anticipated depreciation or appreciation of the currency. As I write this 45.7 Rs are required to get yourself a US Dollar.

I will take the oft discussed parameters first, give my own very limited take on them(I am no forex expert) and then take up a topic which is a little off the routine track but which according to me may have a significant impact on how things shape up on the currency front.

Current Account Deficit(CAD).
We seem to be headed for the deficit of order of 50-60 bn USD. So roughly that is what is we require is terms of net capital inflows to balance things out. So FDI + FII +External credit flow has to be roughly in that range.
The CAD in our case if very sensitive to crude oil prices. Discussion on where crude oil prices are headed is beyond the scope of this write-up and of course, beyond the scope of my capabilities. So we are assuming that crude oil prices will remain in the range they are in right now i.e. 80-100$.
With FDI in the range of 15-25 bn USD, we will require another 20-30bn USD of FII flows. And that is where our well understood vulnerability to FII flows originates.
For the last two years, since the markets have bounced back, the discussion routinely figures around how the inflows will overwhelm the Indian system and lead to significant rupee appreciation. It did happen that way for the first few months. And rupee went to 44 to the dollar. After that it has taken a slightly different turn. The FDI bit slowed down. They were replaced by ECB flows to some extent.Oil prices went up from 60-70$ range to 80$. And rupee has turned back towards 45-46 range. So net net on this particular front the inflows outflows seem to be balancing out as of now.

FOREX RESERVES

Everybody seems to be very excited by the pile of dollars we have accumulated. Recently there was an article in a leading fortnightly business magazine which talked about the problems India faces with the bulging forex reserves and how it will head towards the 500 bn USD + mark over the next few years.
But what does not get the required attention is that the External Debt for India is as big as the forex reserves themselves. Its like showing cash on the balance sheet by borrowing and claiming to be in the pink of health. And good chunk of the debt also some from short term credit and thus will act as a pressure point for the Rupee when that is repaid.

With our CAD and policy paralysis which FDI hates, forex reserves have to come from borrowing and the so called "hot money", which has no longer term loyalty.

I think forex reserves are more a psychological relief than anything else.

So we have a had a look at the two most often discussed forex topics in the Indian context. Cant reach any definite conclusion, can you?
So where has the headline come from?
hmmm.....lets see if I can convince at least one of you. (I hope this is read by more than one, at least..:-) )

- I have written my opinion about the power industry in India in one of my blogs before. those interested may go here...
http://rmbworld.blogspot.com/2009/12/coming-power-ful-collapse-writing-after.html

I can tell you that the state of the SEBs in India has only gone much worse than what was mentioned in the article. Their losses this year are estimated to reach a figure closer to 100,000 cr(this is the ministry and planning commission estimate). Yes you read that right!! If so, that figure is bigger than the now famous oil subsidy bill.
Merchant power rates are probably down by 20-30% over the last one year.
There is a total of more than 100,000 MW under different stages of completion. Some are close to commissioning, some are half way through and some are designing their way up. At close to 5 cr per MW, we can roughly calculate the quantum of money that has gone into them or is going to go into them.
All of them are going to require coal, whether they import it or Coal India supplies them if yet to be seen. Coal India has already cut down its production estimates for FY12. Those who will import need to figure out where they will be able to source coal, at what price, which port has the capacity to import not far away from wherever they are?
Banks have funded these projects providing 70-80% of project costs.
Any problem in this sector is going to be a huge headache.
Banks are also funding SEBs with a total exposure of closer to 100,000 cr. I have no idea how SEBs are going to repay that money with their loss run rate. Are the state govts in a position to handle the total debt of these SEBs which now total up 300,000 cr.?

This has the potential to become India's "sub-prime". And if it turns out that way its not going to be funny.
And it has implications for the banks, infrastructure companies, financial markets, foreign flows and so for the currency as well.
And it doesnt look like that fiscal deficits are going to go down dramatically given the way govt wants to spend money in mostly non-productive purposes. In fact today more than 25% of govt revenues go into interest payments on the accumulated debt.
And in all this I am not discussing the oil subsidy bill, fertiliser subsidy bill and food subsidy bill.
Enough is already said about them.

And the other important thing is that these are domestic problems and have got nothing to do with external events.


What can go lead to rupee to appreciate or stay around where it is?

- Oil goes to 50-60$. But that would mean the one or two countries have gone bust and there is a global collapse or problem. That would also probably have taken the stuffing out of the indian markets and lead to serious FII outflows. So I am not sure that it is going to sustain the rupee.

- Overwhelming foreign inflows. Possible. But if the situation in the power industry turns out the way we have discussed above, then overwhelming foreign flows are difficult to imagine.

- Compression of CAD due to exports rising faster than imports. This scenario and appreciating currency probably hand in hand for too long, because an appreciating currency will have its impact on the exports.

- Phenomenal Dollar weakness. Cant rule that out . But against which currencies?

All this put together, I would bet that Rupee has a higher probability of depreciating rather than appreciating.
And my headline already makes my direction call clear.

Of course, I am no expert. But I am also ready for brickbats.