The fall in the value of rupee, which is nearing 66 a dollar, is likely to impact corporate earnings and exchange rate becomes the only critical factor to determine corporate profitability.
People’s Bank of China changed the way it calculated the reference rate of yuan recently, which led to more than four per cent fall in Chinese currency against the dollar. This fall in yuan, prompted other countries to resort to competitive devaluation of their currencies to support their exports.
The yuan devaluation reflected the market concerns regarding a slowdown of Chinese economic growth and flagging exports, says ICRA in its report. “This has given rise to the apprehensions that the currency may weaken further unless Chinese macroeconomic fundamentals stage an improvement and that the devaluation had actually been permitted to boost the competitiveness of Chinese exports.”
The RBI Governor Raghuram Rajan aptly said that the Chinese move raises questions on the strength of their economy. “If Chinese depreciation holds around this level it should be fine. If it is more, it will be worrisome. You could have tit for tat actions.”
In India, the sectors expected to be directly impacted by yuan devaluation, according to ICRA, include, steel, tyre and auto component as these sectors have a large overhang of Chinese capacity in the global market. This apart, it says the power and telecom sector would also be impacted indirectly by devaluation of rupee against the dollar, due to a combination of increase in input costs and foreign currency borrowings.
RBI study The RBI had come out with a working paper recently which talks about rupee’s exchange rate against the dollar as most important risk component for Indian corporate profitability.
It says that during 2002-07, corporate profitability was mostly influenced by firm-specific indicators such as firm size, leverage, liquidity etc. However, since 2009, the domestic economy became more integrated with the global economy and also more sensitive to external shocks.
“This was a fact and could be seen clearly without much analysis,” says Samir Lodha Managing Director, QuantArt, a foreign exchange advisory firm.
According to him, manufacturing and infrastructure sectors have been facing demand slowdown, excess capacity and saddled with extremely high interest rates. “The real test of rupee management is now and was not when Mr. Rajan took over rein — that time Bernanke (the then U.S. Federal Reserve Chairman) already calmed the market and RBI doled out huge discount to FCNR depositors (which essentially benefited foreign banks),” Mr. Lodha added.
The RBI study says that the importance of macro economic factors such as exchange rate, interest rate and the wholesale price index (WPI) inflation rate to determine corporate profitability is amplified. “Among them, the exchange rate of rupee compared to the dollar was a significant factor whose importance has increased manifold in recent times.” “The exchange rate is negatively associated with corporate profitability indicators…Therefore, it can be inferred that when rupee appreciates, corporate performance is likely to get a boost in terms of profitability, though in the long run the impact would depend on the import and export elasticities.” This gels with the nature of Indian corporate sector carrying out more imports than exports.
As import gets cheaper when rupee appreciates, corporates are likely to be benefited from that. In a scenario of persistent large depreciation of domestic currency, the performance of the corporate sector is expected to be impacted negatively, which may in turn affect the banking sector.
For non-oil companies also, the study says, the exchange rate is a significant factor behind their profitability which is negatively associated with profitability indicators.
In the post financial crisis period, many of the large private non-financial corporates in India have resorted to behave like financial intermediaries to take advantage of the easy liquidity abroad. The RBI study says this has amplified the impact of exchange rate volatility on their profitability. Any uncoordinated monetary policy actions by the developed economies can result into increased volatility in exchange rate in emerging market economies (EMEs).
