Outlook for euro, pound and yuan

Major currencies such as the euro, the pound and the yuan, besides the dollar, are critical to India’s trade. An analysis

The Indian rupee has been falling sharply against the US dollar since the beginning of this year; losing 6 per cent so far in 2018. This fall and the rupee’s under-performance against the dollar have been hogging the headlines. But the rupee’s performance against other major currencies such as the euro, British pound, Japanese yen and the Chinese yuan goes mostly unnoticed.

The movement of the rupee against all the major currencies is not always in the same direction. For instance, even as the rupee strengthened 6.3 per cent against the dollar in 2017, it had weakened 6.3 per cent and 3.2 per cent against the euro and the pound respectively. It has been slightly different this calendar; the rupee has been sliding against all the major currencies. That said, the decline relative to the yen and the yuan has been sharper at more than 7 per cent. Against the euro and the pound, the rupee is down about 4 per cent.

A dissection of India’s trade data reveals that the rupee’s performance against the euro, the pound and key Asian currencies such as the yen and the yuan are also quite significant. While the settlement of exports and imports from these regions may happen in dollar terms and not in the respective domestic currencies in some cases, the value of the domestic currencies is significant, as that determines the final transaction value in dollars.

The trade pie

The Ministry of Commerce publishes India’s trade (export and import) data in net dollar terms. The break-up of India’s trade in different currencies such as the euro, the pound and the yen is not available officially. The trade data received from the Customs and Special Economic Zones (SEZs) in rupee terms is converted into dollars based on the Reserve Bank of India’s monthly average conversion rate. In other words, the cross currency rate of every trading partner country of India is equally important.

Though the US is India’s largest exporting destination, with 16 per cent share, when it comes to region-wise trade, Asian countries are the top buyers of Indian goods. On an average, about 49 per cent of India’s export goes to Asian countries. United Arab Emirates, Hong Kong, China and Singapore are the top nations in Asia. Europe and the Americas (North America and Latin America) share the second spot by accounting for 20 per cent each of India’s exports. The UK and Germany are the top European export destinations for India. Each of them account for 3 per cent of India’s exports.

Oil as a commodity influences the country’s import bill to a large extent. But interestingly, when it comes to country-wise imports, India buys the most from China. India’s import of $76.27 billion in the last financial year 2017-2018 (FY-18) from China constituted 17 per cent of the country’s total imports. Indeed, China’s contribution to India’s imports has surged by 46 per cent over the last five years, from $52.25 billion in FY-13. The trade deficit with China has widened from $38.7 billion in FY-13 to $62.9 billion in FY-18.

Imports from the Gulf Cooperation Council (GCC) countries (UAE, Saudi Arabia, Qatar, Oman, Kuwait, Bahrain) — the leading destination for oil purchases — have taken a backseat over the last few years. This is due to the sharp fall in oil prices. India’s crude basket prices have have tumbled 48 per cent from an average of $108 per barrel in FY-13 to $56 per barrel in FY-18. As a result, the import bill from the GCC region has fallen substantially, from $108 billion to $64 billion over the same period. However, the recent surge in oil prices to $76 a barrel (Brent Crude) may put pressure on the import bill from the GCC region this fiscal.

Deficit woes

Barring the Americas, India has been running a trade deficit with all other regions over the past several years. In FY-18, India had the highest deficit with Asia at about $130 billion, followed by Africa and Europe with deficits of $12.9 billion and $9.6 billion respectively for the same period.

Given the quantum of India’s exposure to Europe and Asia, especially China, it is imperative to track the performance of the currencies pertaining to these regions to arrive at the country’s trade bill. We analyse the reasons behind the rupee’s weakness and the economic outlook of the euro region, the UK and China to gauge the impact of the respective currencies on the rupee and India’s trade.

Rupee’s moves

Although the Indian rupee posted a robust 6 per cent rally last calendar year against the dollar, it weakened against other majors like the euro and the pound. The rupee was down 6 per cent against the euro and 3 per cent against the pound in 2017.

 

 

 

The prime reason behind the rupee’s under-performance against these currencies has been the strength of the euro and the pound last year. Strong prospects of an economic recovery in the euro zone and expectations of the European Central Bank (ECB) tightening its monetary policy strengthened the euro all through 2017.

The pound, on the other hand, recovered on the back of a smooth exit from the European Union. The expectation of the Bank of England (BoE) raising its interest rates also kept the pound stronger last year. Indeed, the BoE increased the rates by 25 basis points for the first time in a decade last November.

The rupee’s weakness against these major currencies has continued this calendar as well. This has been due the fundamental weakness in the rupee. It moved lower by about 4 per cent each against the euro and the pound and 7 per cent each against the yuan and the yen.

The draggers

Three major factors — foreign money outflows, widening deficit and oil prices — have been dragging the rupee down this year. Brent crude oil prices breaching $70 per barrel for the first time since 2014 and rallying towards $80 has raised the concerns of a costlier import bill which may, in turn, widen the trade deficit and the current account deficit (CAD).

Crude oil constitutes about 26 per cent of India’s import bill. Rising oil prices have seen oil imports go up by 25 per cent to $108.7 billion in the last financial year. This has widened the trade deficit to the highest in five years, to $156.8 billion in FY-18. The CAD, as on December 2017, stands at $35.68 billion. The threat of higher oil prices and widening trade deficits are likely to keep the rupee weak.

The second factor keeping the rupee under pressure this year is the outflow from foreign portfolio investors who have been on a selling spree in the Indian debt segment. The FPIs have off-loaded $5.2 billion worth of Indian debt so far this year. This has been the highest ever outflow in the first half of the calendar year, as per the data available since 2002. The threat of more outflows in the coming months remains after the the Federal Reserve increased its rate by 25 basis point and announced that there will a total of four rate hikes this year. Previously, the Fed had indicated that it would increase the rates thrice this calendar. The threat of widening deficit and foreign money outflows are likely to keep the rupee weak in the coming months.

Influence of ECB and BoE

The European Central Bank (ECB) announcing an end to its bond purchase programme by this December is positive for the euro from a long-term perspective. The currency has been beaten down after the ECB meet last week, as the market was expecting the central bank to end its bond purchase by September. However, the currency is expected to recover towards the end of the bond purchase programme. This could keep the euro stronger.

Similarly, more rate hikes are expected from the Bank of England this year, following its first rate hike in a decade last November. This could keep the pound strong.

Growth prospects

The growth prospects of the Euro area are positive. The International Monetary Fund (IMF) forecasts the euro area to grow at 2.4 per cent this year, up from 2.3 per cent in 2017, on the back of strong domestic demand, supportive monetary policy and prospects of better external demand. This is positive for the Euro. Good growth prospects can keep the rupee weak against the euro.

On the other hand, the business climate in the UK is expected to slow down as the country exits the EU. As a result, IMF forecasts the UK to grow at a slower rate of 1.6 per cent in 2018 after having grown at a faster pace of 1.8 per cent in 2017. So, the rupee may remain weak against the pound. However, the weakness could be capped on the back of a slower growth in the UK.

The impact of the Brexit has been largely priced in the currency already. Any developments on this front could be short-lived, going forward. As such, the downside in the pound could be limited.

For China, the IMF expected the growth to slow down to 6.6 per cent in 2018 from 6.9 per cent in 2017. It cautions that the increasing non-financial debt-to-GDP ratio in China is a concern for growth.

This could limit the weakness in the rupee against the yuan. But the increasing dependance on China for imports may keep the demand for the yuan higher which, in turn, could restrict the strength of rupee against the yuan.

What the charts say
  • Major currencies such as the euro and the pound are likely to weaken against the dollar in the short term and recover over the medium term. This might give some respite for the rupee against the majors. However, the rupee strength against the majors is expected to be short-lived and the domestic currency is likely to weaken, going forward.
  • The euro came off sharply against the dollar last week after the ECB meeting. It trades at 1.16. Though the current fall can extend to 1.14 or 1.13 in the coming weeks, a break below 1.14 looks unlikely. A strong upward reversal from the 1.15-1.14 support region has the potential to take the euro up to the 1.20 levels again.
  • Against the rupee, the euro has reversed lower after making a high of 82 in April. It now trades at 79. A key support at 78.5 is holding well, as of now. There is another strong support at 77 which, if broken, can drag the euro lower to 75 or even 72.5 in the coming months. Though an intermediate dip to 77 cannot be ruled out, a strong fall breaking below 77 looks less probable.
  • A range-bound move between 77 and 82 is possible in the short term. The region between 82 and 82.5 is a strong resistance for the euro. A strong break above 82.5 will take the euro higher to 86 or 87 against the rupee in the coming months.
  • The British pound has been on a steep decline against the US dollar since April from a high of 1.44. It trades at 1.33. This fall can extend in the short term, but is likely to halt at 1.30 or 1.29.
  • A strong bounce from the 1.30-1.29 support zone will increase the likelihood of the currency revisiting 1.40 or even 1.45 against the dollar. Against the rupee, the pound has a key support near the current levels of 89.5 and a strong trend support at 88.5.
  • A dip to test these supports in the short term cannot be ruled out. But a break below 88.5 is unlikely. A bounce from 88.5 will see the pound rallying towards 95 against the rupee in the coming months.
  • The Japanese yen has strong resistances against the US dollar at 108 and 105. As long as it trades below these hurdles, it is likely to weaken towards 115 or even 117 against the dollar.
  • The yen-rupee pair has been stuck in a narrow range between 60.5 and 62.5 for more than three months now. A breakout on either side of 60.5 or 62.5 will decide the next trend. A break below 60.5 will drag the yen lower to 59.5 or 59 in the short term. Further fall below 59 is unlikely at the moment. A bounce from the 59-59.5 support zone will take the yen higher again to 62 and 62.5 against the rupee. An eventual break above 62.5 will increase the likelihood of the currency targeting 64.5 or even 66.5.
  • The yuan has been weakening against the dollar over the last three months. The currency has tumbled from a high of 6.24 in March to the current levels of 6.43.
  • A crucial support for the yuan is at current levels. A strong break below 6.43 will see the yuan weakening towards 6.48 and 6.50 in the coming months.
  • On the other hand, if yuan reverses higher from current levels it can strengthen to 6.39 again or even to 6.32 in the short term.
  • Against the rupee, the yuan has been in a strong uptrend since April. The currency has risen from a low of 9.27 in April to a high of 10.72 in May. It has come-off from this high and trades at 10.57. A crucial resistance is at 10.60 and at 10.75. A strong break above 10.75 is needed for the yuan to rally further. This can take the currency towards 11.20. Indicators on the charts are bullish. The 50-week moving average is on the verge of crossing over the 200-week moving average. This is a bullish signal, indicating that the possibility is high of the currency breaking above 10.75 and rallying to 11.2 against the rupee in the coming months.

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