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The term 'Fragile Five' came into the spotlight a little over a year ago. It represented emerging market economies that were relying on unreliable foreign investment to finance their growth. India was one of the counties that formed part of this list; others were Turkey, Brazil, South Africa and Indonesia.

In relative terms, India's health has improved the most. Not only has the Rupee appreciated by about 12.1% since last year, but the country's key pain point at the time - the burgeoning current account deficit (CAD) - has reduced substantially; from 4.1% in September 2013 to 1% in June 2014 (on a trailing twelve month basis). While other nations have also seen an improvement in their CAD figures, they are nowhere comparable to that of India's. Also barring Brazil, the respective currencies of other three nations depreciated against the American Dollar.

As you would be aware, it was the gold and merchandise imports that were playing havoc with our current account deficit numbers. Therefore in order to deal with gold, Government made it difficult to import the yellow metal by raising duties. Consequently, it is expected that once duties are reversed, the demand will bounce back and once again hurt our current account deficit. This is where the Morgan Stanley guys have dug a bit deeper and come to the conclusion that gold demand may not be as strong as in the past because its allure as an investment asset has gone down. It should be noted that in Mid-2011, the investment demand for gold formed about 40% of the total gold demand in India. This is nearly twice than what the long term average suggests. Therefore if the investment demand for gold has to go back to the long term average and if consumption demand maintains its long term trend, then we could indeed save on some precious foreign exchange reserves and in the process sustain our strong current account position. As for non-gold imports rising as and when GDP increases, the report goes on to indicate that there is no correlation between the two. And with prices crude oil - the key contributor to the non-gold imports - remaining low in present times, the normalized CAD level is expected to remain at comfortable levels in the coming future.

DXY – Dollar Index…

In the past few months, US Dollar (DXY*) index has strengthened ~ 6% towards 85.30 levels. This has been primarily because of the diverging trend in the US Federal Reserve vis-à-vis European Central Bank (ECB). While the Fed is likely to move towards neutrality, the renewed risk of fading recovery in the Euro zone (EZ) has forced ECB to move towards further easing. Consequently, Euro has fallen towards 1.27 against USD. Many other major developed market (DM) currencies have weakened, helping DXY index to reach 14-month highest level. This trend is likely to be reinforced further, as the Fed’s move towards neutrality becomes more apparent.

…however, EM currencies have been resilient

Contrastingly, emerging market currencies have exhibited great resilience against USD. In the past six months, while Indian Rupee (INR) has been largely flat, other Asian EM currencies such as Thai Baht (THB), Malaysian Ringgit (MYR), Philippine Peso (PHP) and Taiwanese Dollar (TWD) have strengthened against USD. Indonesian Rupiah (IDR), on the other hand, has weakened 3.7%.

The trend could reverse soon for EMs including India

This, we believe, could reverse soon. Fading recovery in the EZ, which is one of the major trading partners for all emerging markets, and reversal in easy monetary policy by the US could subject capital inflows in emerging markets to risk.

India, in particular, would also not be able to remain unscathed. The decline in responsiveness of the INR/USD to strengthening of DXY may be a short term phenomenon. The INR/USD elasticity with respect to DXY index has generally been very high (0.86) in the post 2008 crisis period. INR may test 61.80 in the coming month and in two months time it can test 62.00 on upper side.

Disclaimer

These deal indications are only advisory in nature and may not be true in 100% cases. Read more....