Rajan weighs his options as rupee gets big Modi lift
May 13 2014 , Mumbai
A strong rupee can hurt exports, dollar buying may stoke inflation
The domestic currency rose the most in two weeks on Tuesday to close at 59.68 against the US dollar after exit poll projections of a clear verdict for the Narendra Modi-led NDA in the national election buoyed the financial markets.
Analysts expect the rupee to appreciate at a faster clip as political stability and reform hopes are likely to increase portfolio flows to domestic equities and bonds. Many expect RBI to lap up the incremental dollar flow to protect domestic exports, which is important to stabilise trade deficit, and thereby current account deficit.
The central bank has bought dollar assets worth $10-15 billion from the open market in the last two months. According to the RBI website, it bought net $7.78 billion of foreign currency in March from the spot market and $31 billion outstanding from the forwards market.
“We expect $25 billion portfolio flows, which can pressure the rupee to appreciate to 57-58 level against the dollar. At the same time, we expect it to settle round 60 to the dollar as RBI is likely to buy forex to push up import cover from 7.5-8 months to 10 months essential for rupee stability. Our global forex team expects the dollar to appreciate to 1.25 to the euro by December,” Bank of America Merrill Lynch said in a report.
Foreign institutional investors (FIIs) purchased stocks worth net of Rs 2,026.23 crore on Tuesday, indicating their bullishness on the market. Their total investment in equity this calendar stands at $5.96 billion.
“RBI is looking more from export competitiveness perspective,” said Anindya Banerjee, a currency analyst at Kotak Securities.
Banerjee expects constant appreciation of the rupee if it is left to the market forces to decide. “This would be detrimental to exporters and would also lead to excesses (imports become cheaper and domestic production becomes uncompetitive) resulting in high current account deficit,” he said.
The central bank has time and again emphasised that it does not target a specific level for the rupee. At the most, it will allow calibrated appreciation of the rupee. “RBI will not target a level but look at a stable appreciation in the range 59.2 to 60.5,” Banerjee said.
Finance minister P Chidambaram recently pegged the right value of the rupee in the current situation at 60 to the dollar, saying “it is true reflection of the currency value.”
Rajan spent the first seven months since he took over as RBI governor on September 4, 2013, trying to stem the rupee slide, which hit the lowest level of 68.82 against the dollar on August 28, 2013. A slew of measures by RBI and the central government helped the currency to recover to the 60 level on March 28.
Historically, RBI has been a much stronger defender of the dollar than the rupee. It has played a much effective role when the dollar depreciates than when it appreciates. Between the first quarter of 2004 till the first quarter of 2007, the rupee ruled in the 43-46.5 range. Sensex rose 2.5 times during this period and RBI bought $100 billion from the open market to support the rupee.
“RBI has enough arsenal to support the dollar-rupee range. While it cannot sell its entire forex reserves to arrest a depreciating rupee, it can buy unlimited dollars by printing more rupees in case the rupee appreciates,” Banerjee said.
But that can leave the central bank in a quandary, as buying dollars means creating extra liquidity in the system, which can push up inflation, something RBI can ill-afford. A weaker rupee, on the other hand, can erode the nation’s export competitiveness.
India’s exports rose 5.26 per cent in March to hit a five-month high of $25.63 billion, narrowing trade deficit marginally to $10.09 billion.
Saugata Bhattacharya, chief economist at Axis Bank, said, “Market indications are that RBI is intervening more in the forwards market than the spot market. Larger interventions in the spot market results in higher liquidity, releases more money and can potentially impact inflation.”
Bhattacharya, however, says the spurt in the rupee could be temporary. “RBI believes the political outcome could result in a temporary spurt, which might not sustain, as investors may book profits and the rupee may eventually come back to 59-60 level. In such a case, the central bank may not intervene too much, but only to smoothen volatility. There are some indications that 59-60 may be a fair value for the rupee,” he said.
On Monday, exit polls suggested a majority verdict in favour of the BJP-led NDA in the national election. The dollar-rupee pair made a high of 59.93 and a low of 59.59 on Tuesday.
Local bourses continued to be in joyous mood, as they closed at their new life-time highs. Sensex crossed the key psychological level of 24,000, up by 2.2 per cent, and Nifty touched 7,172.35 level, up by 2.25 per cent during the session. Profit booking pared gains in the second half, making Sensex and Nifty settle at record highs of 23,871 and 7,172.