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China’s trade deficit is negative for the Indian Rupee The Rupee has been extremely resilient in the

face of adversity. Calendar year to date the Rupee is down .5% while the Sensex is down over 10% and oil is higher by 33%. The resilience of the Rupee defies norms as weak equity and strong oil prices are negative for the Rupee. Equities have fallen largely on the back of FII equity sales where FII’s have been net sellers to the extent of USD 2 billion calendar year to date. The Rupee/ FII sales correlation is high, as seen by the fact that the Rupee gained 5% from lows of Rs 47 to the USD in mid 2010 on the back of strong FII flows. FII’s brought in USD 28 billion in calendar 2010. Given that India imports more than 70% of its oil requirements, rising oil prices increases the import bill leading to a widening trade deficit and pressurizes the current account deficit as well. However, recent trade data suggest that oil prices are yet to impact the trade deficit as trade deficit has steadily come down from highs of over USD 12 billion to below USD 3billion. The high oil price impact will be felt in the coming months and trade deficit is bound to go up on higher oil import bill. The one factor that could make the Rupee go the other way is the sudden trade deficit numbers reported by China. China reported a trade deficit of USD 7.3 billion for the month of February 2011. Analysts were expecting a trade surplus of USD 4.9 billion for February. Trade surplus for January 2011 was USD 6.5 billion (all Bloomberg data). The sudden swing from surplus to deficit is negative for the Renminbi (Chinese Yuan) as the currency has appreciated 4% year on year against the USD on the back of calls for revaluation of the currency. China’s currency is pegged to the US Dollar and given that China runs a large trade surplus with the US by not allowing its currency to appreciate, it has been a bone of contention between the US and China. Calls for a stronger yuan also helps other countries like Brazil and South Korea to let their currencies appreciate which otherwise would have made their exports uncompetitive vis a vis China’s exports. A trade deficit gives China strength to keep away critics and maintain status quo on the Yuan rate. If trade deficits continue, then China may even weaken its currency, leading to speculative positions on a stronger yuan being unwound. This will hit emerging market currencies including the Indian Rupee. The Rupee is now vulnerable from three fronts, weak equities leading to FII outflows, high oil prices leading to higher oil import bill and China’s trade deficit leading to speculative positions on stronger emerging market currencies being unwound. email: arjun@arjunparthasarathy.com www.arjunparthasarathy.com blog: www. parthasarathyarjun.wordpress.com