Since May 16, rupee health deteriorates

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Dollar-rupee volatility touches February level

Since May 16, rupee health deteriorates
The rupee is trading poorly these days and has been the worst performing Asian currency in the last three months. Sample this: since May 16, when the Narendra Modi-led Bhartiya Janata Party swept the polls during the Lok Sabha elections, the Indian rupee has depreciated by 4.23 per cent. In comparison, the Indonesian rupiah has depreciated by 2.28 per cent, South Korean won (KRW) has depreciated by 0.65 per cent, Japanese yen by 0.63 per cent. However, Chinese yuan has appreciated by 1.32 per cent.

The reason for a steep depreciation in rupee is largely the high trade deficit and a high current account deficit (CAD). With the month-end demand for dollars coming in the next two weeks from oil marketing companies, the rupee could depreciate further, said analysts.

On Monday, the partially convertible rupee closed at 61.19/20 per dollar, compared to Friday's close of 61.14/15. The unit had dropped to 61.74 last week, its lowest since March 5.

“Since May, the RBI has been continuously buying dollars in the market, which has played a big role in depreciating the currency and keeping the rupee below 60 levels. There is no disenchantment with the government on reforms as the stock markets have risen at 7,800, corporate results have been positive while economic growth forecast for the year has been revised upwards to 5.5-6 per cent. The reason is that the US economy is becoming strong,” said Anil Bhansali, vice-president, risk advisory at Mecklai and Mecklai Financial Services.

The US added more than 2 lakh non-farm jobs in the last six months and reported a 4 per cent better than expected economic growth in the three month ended June 30.

"Risk appetite has gone down in the last few days. I expect the rupee to be at 62-62.25 levels in one month,” added Bhansali.

India is mostly dependent on foreign flows to bridge the gap created by CAD and allows Indian corporates access to foreign capital at a cheaper rate.

Because of the reliance on the volatile capital flows for the currency, the rupee is also more exposed to vulnerabilities than most other Asian currencies due to the current account deficit.

“Once the Fed ends its programme and increases rates, the rupee could be more exposed to vulnerabilities. I expect the rupee to be in the range of 60-62.5 levels in one month,” said Anindya Banerjee, currency analyst at Kotak Securities.

According to latest data from RBI, foreign exchange reserves fell by $573.5 million for the week ending August 1 to $319.99 billion. Foreign currency assets, a key component of reserves fell by $1.09 billion to $ 292.69 billion.

During a media interaction, when Financial Chornicle asked RBI governor Raghuram Rajan if there could be a flight of funds from India in case the US interest rates go up, Rajan said, “There will be volatility. Every time the US sneezes, the emerging markets around the world catch cold. Your main hope is that we don’t catch pneumonia. I think, what we have done over the last year-and-a-half in stabilising the macro economy should help us sustain the initial bout of volatility which I have no doubt will happen.”

“But look beyond when people are differentiating, remember the taper tantrum that started in May last year, the initial bout was non-discriminating. In fact, emerging markets which were stronger experienced more selling because there you could get out without so much of a liquidity impact. Over time, investors re-assessed what were good markets and what were not-so-good markets or bad. Now I think relative to a number of countries, the perception of India is somewhat stronger. Whether it meets the euphoric perception that suddenly emerges, one can debate, but it is certainly stronger than some of the countries which have political issues that need to be dealt with and where growth is so tepid. But are we immune? The answer is no,” said Rajan.

According to Madan Sabnavis, chief economist, Care Ratings, the rupee has been guided largely by fundamentals. “One can sense that the trade deficit has started widening due to recovery in industry which, combined with the FII slowdown, has pressurised the rupee. The RBI appears to be comfortable with the rupee above 60 and buys up dollars when it goes below 60. Forecast is that it will be range-bound in 61-62 till September end,” said Sabnavis.

At an absolute level, the fiscal deficit in Q1 FY15 is 13 per cent higher than the level in Q1 FY14, partly on account of unfavourable tax growth. CAD narrowed considerably to 1.9 per cent of GDP at the end of Q1 this year.

According to analysts, rising geopolitical risks, coupled with fears of softening in reform expectations on the domestic front, are the key downside risks to the currency. Analysts said a deterioration in the external sentiments through events such as US Fed's tapering, rising geopolitical tensions such as Iraq crisis, Ukraine and Russia tensions, and conflict in Gaza strip are the key downside risks to the currency.

HSBC Global Research, Asian FX in a report said that the policy preference for exchange rate stability still exists but this cannot be guaranteed, especially if a climate of dollar strength gathers momentum.

The report says that in the run-up to and after India’s parliamentary election on May 16, capital inflows were very strong but this was matched by the RBI building forex reserves. This year, capital inflows to local equities and sovereign debt reached a total of nearly $26 billion while spot forex reserves increased by $25 billion (as of August 5 and July 25, respectively). The end-result was that volatility in dollar-rupee was steadily compressed.

“But we have started to see some tremors emerge in the rupee with, for example, the realised volatility of dollar-rupee being back at levels seen in early February. And we take note of RBI policy statement this week in which governor Rajan highlighted how emerging market economies have received large portfolio inflows and these could be at risk if the market turns jittery about the end of Fed’s tapering or geopolitical risks. With India having received a large amount of portfolio inflows this year, his comments are a subtle warning that the rupee could suddenly trade with greater volatility should portfolio inflows reduce or if there is greater FX hedging of the underlying assets. In addition, India still runs a current account deficit," said the HSBC report.

Pramit Brahmbhatt, chief executive officer of brokerage company Veracity Group said, “In the budget, the government didn’t have place to make major policy moves, which led to some technical correction in the Indian stock markets, which again took rupee towards 60 level. However, the rupee again got stronger and made positive gains post budget as the market gave positive reaction to the budget. After the budget, scenario completely changed due to the global crisis in Ukraine, Gaza and Iraq that has create global insecurity.”

Crude prices were stable but gold and dollar outperformed and was stronger against the global peers. This also affected the Indian rupee against the dollar: the rupee moved in the range of 61.

“The Iraq crisis is amongst the biggest concern for global investors and this might weaken the rupee. We could see it in the range of 62 if Iraq gets vulnerable and US intervention increases,” said Brahmbhatt.

“The current pressure point for the INR is less to do with a domestic story losing its shine but instead the external environment becoming more uncertain. Indeed, some of the inherent vulnerabilities behind the INR are less acute than they used to be. But that does not mean that the INR is out of harm’s way nor should we lose focus on what’s happening domestically. Since the election, there has been closer scrutiny on the nature and pace of reforms that Modi would lay out which could improve the structural flow backdrop for the rupee, and help to boost long-term growth and curb inflation. The influx of portfolio flows suggested that the market was confident that these structural reforms would come through eventually. However, there is a risk that the reform process starts to lose momentum, and the capital inflow which supported the INR earlier starts to dry up, or in the worst case, actually reverses," said the HSBC report.

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