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Uncertainty over the Indian government’s proposed share sale of the Life Insurance Corporation of India (LIC) is not only risking its own finances but also pressuring the rupee.
The government has secured approval from the stock market regulator for the share sale of LIC – the size of which has already been termed as ‘unprecedented’. At the market expected size of INR600-750bn ($7.8bn-$9.7), not less than $2bn worth of foreign currency is expected to flow into the local market and help the rupee recoup some losses from its record low level of INR77.15 touched last week after the Ukraine-Russia standoff pushed global energy prices to a multi-year high.
LIC’s share sale holds the key to the government meeting its target of raising funds from the sale of stakes in state-owned companies of INR780bn for the year ending 31 March 2022, which is just 17 days away.
According to the draft prospectus or early papers, the government will issue up to 316.2 million equity shares through the offer for sale, representing 5% of the equity of LIC. The price per share is yet to be announced.
Expectations of analysts from the LIC share mop-up ranged from INR600-750 at a time when overseas investors have already liquidated local assets worth over INR1trn.
Foreigners selling big
“Foreign portfolio investors (FPIs) were expected to subscribe to this IPO in a big way. The postponement of the IPO could postpone the dollar inflows into India. Given the fact that the FPIs have been large net sellers of Indian equities this calendar year, the rupee is already under pressure,” said Deepak Jasani, head of research at HDFC Securities.
“The street is aware of the possibility of postponement of LIC initial public offering (IPO) and hence the official announcement of postponement may not lead to a large impact on the USD/INR rate,” he added.
Typically, the Indian rupee weakens rather quickly when crude oil prices rise, as the nation meets over 80% of its demand from imports. It is also often pressured by other factors such as interest rate hardening in the world’s largest economies. On the other hand, the rupee draws respite from the pace of economic growth in the country, which is among the fastest in the world, attracting foreign investments.
“Rupee has already seen its level of volatility and weakening and is among the underperformers in the emerging market. We witnessed weakness in the rupee currently because of large outflows from equities and some of that will reverse if the LIC IPO comes in,” said Anith Rangan, an economist at financial advisory firm Equirus.
“However, given high oil prices, even if the geopolitical tension abates, the current account deficit will be an overhang pressuring the rupee. Overall, gradual depreciation is the course the rupee will take,” she noted.
High inflation from supply blockage
The surge in crude oil prices and stronger US dollar are a lethal combination for countries like India which are dependant energy imports.
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Geopolitical worries have not only pushed crude oil prices higher but also created supply blockage for many commodities, which has resulted in higher inflation, worrying investors and preventing them from increasing exposure in India. That is going to keep the rupee under sustained weakening pressure.
“In the event of continuation of Ukraine-Russia standoff and if crude sustains above the $120 mark, we could feel the heat in terms of higher inflation that could result in unfavourable conditions for the rupee and rupee-denominated bonds,” Jasani said.
The rupee is expected to draw comfort and reverse losses by the large foreign exchange reserves the central bank has built.
India’s net foreign exchange reserves were $631.9bn as of 4 March, up by $51.6bn from the past year. That is the fifth-largest holding of international reserves in the world. India’s international assets cover three-fourths of India’s external liabilities, including debt, equity and all other forms of contractual obligations.
“The volatility in crude oil prices will dictate the trend in the rupee which has been among the weaker emerging market currencies since the crisis started, given the preponderance of energy imports as well as large FII outflows,” said Aditi Nayar, chief economist at ICRA.
“We expect the INR to trade in a range of 76-79/US$ in the duration of the conflict, with an easing to 74-77/US$ after the conflict ends, and normalising global sentiments spur renewed FII inflows. Given the substantial forex reserves in excess of 12 months of trailing 12-month imports, we do not foresee a disorderly depreciation in the INR going ahead,” Nayar said.
‘No clarity on capital flows’
The level of foreign exchange reserves has risen to 20.5% of gross domestic product from 16% at end-March 2013. The import cover provided by the reserves has doubled while short-term external debt has declined over the same period to 40.3% from 59%.
“Geopolitical conflict has drastically altered the global environment and the context in which monetary policy operates. As investors re-assess risks and sizable reallocations appear imminent, there is no clarity on the direction and magnitude of capital flows for any specific country,” said Michael Patra, a deputy governor of the Reserve Bank of India.
For India, direct trade and finance exposures in the context of the ongoing conflict are limited. Contagion could, however, impact India through a broader fallout on emerging market economies as an asset class. If worry were to give way to panic, liquidity, especially US dollar funding, could dry up and markets could malfunction. With crude oil still above US $100 per barrel, new macroeconomic headwinds could be the second channel of contagion,” Patra added.
Patra also said that reassessment of geopolitical risks could mean an increase in country-risk premiums, a higher cost of funding for emerging market economies and a significant decline in cross-border investment volumes.
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