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Stage set for a strong recovery in rupee

Even though the rupee recorded its historical low in 2008 at 50.58 a dollar, market participants are hopeful that the Indian currency would strengthen against the U.S. dollar in this calendar year. The rupee’s previous historical low was recorded in 2002 when it touched 49.07 a dollar. Moreover, the latest stimulus (fiscal) package announced by the Government coupled with a sharp fall in global crude oil prices is expected to add value to the rupee.

The severe turbulence in the global financial markets has resulted in heightened risk aversion and outflows from emerging markets, including India. As a result of foreign institutional investor (FII) outflows and strengthening U.S. dollar (due to safe haven buying), the rupee weakened in 2008 from the multi-year highs. However, in recent times, the U.S. dollar has pared its gains and weakened against the Japanese yen and the euro due to expectations of further monetary easing in the U.S. This has also helped the rupee recover from the lows.

While a weaker currency helps export-oriented sectors such as information technology, it increases the costs for importers, especially capital goods, and also dilutes the benefit of lower oil prices. The Reserve Bank of India (RBI) and the government have taken various measures to improve capital flows, including relaxation of external commercial borrowings (ECBs), increase in non-resident Indian (NRI) deposit rates and enhanced FII limits in the debt markets.

“India’s external position remains comfortable given the large foreign exchange reserves and a relatively low external debt to gross domestic product (GDP) ratio. We believe that, over the long-term, the rupee will strengthen helped by the expected relative outperformance of the Indian economy vis-a-vis the U.S. economy,” said K. N. Sivasubramanian, Senior Portfolio Manager, Equity, Franklin Templeton.

“The rupee will not breach the 51-a-dollar mark expecting the stock market to show positive movements. Over the next three to six months, this should bring FIIs back into our markets. The Indian currency is likely to strengthen to 46-47 levels over the next six months,” said V. Rajagopal, a leading Mumbai-based forex analyst.

Last year, the entire dollar-rupee movements were influenced by substantial inflows into the country and therafter the drying up of such inflows. Other factors such as heightened oil prices too played a muted role in the currency price. “This year too, I expect the inflows to be the guiding factor influencing the exchange rate of the rupee,” Mr. Rajagopal added.

The monthly trade deficit has gone down from a peak of $30.5 billion to around $10 billion. While these numbers are larger than last year, the trend is evident: It is declining, more importantly, the price of crude has dropped sharply from a level of around $150 to around $40 a barrel.

Since import of crude oil accounts for about one-third of India’s total import bill, the sharp fall in crude prices would translate into big saving in future. Partly, this explains the reducing trade deficit. Going forward, the three main concerns — trade deficit driven by crude oil, negative FII flows and weak ECB inflows — would be resolved: Oil prices have already crashed. Even though exports have come down (exports registered a negative growth for the two recent consecutive months, October-November 2008, for the first time since February 2002), the fall in crude oil prices may more than offset this reduction in exports; the fiscal package announced on January 2, has liberalised the ECB norms that should get inflows back, which again would add to supply in U.S. dollar; the U.S. dollar has acquired a very weak undertone, thanks to the weak U.S. economy; and finally FIIs were seen stop selling.

“Given all these, the rupee is likely to strengthen in the current calendar year. However, given the fact that there may be short-term repayment of ECBs, there may be a short-term weakness in the rupee. But the stage is really set for the rupee to strengthen,” said K. Harihar, Executive Vice-President Treasury, Development Credit Bank.

The fiscal stimulus policy which was announced last Friday has also increased the FII limit in corporate bonds from around $6 billion to $15 billion.

Over the years, capital flows have assumed increased importance in determining the exchange rate dynamics. “The Indian rupee exhibited two-way movement and moved in a broad range of 39.26-43.15 a dollar during 2007-08,” the RBI stated in its latest report on Trend and Progress of Banking in India 2007-08. Large capital inflows resulted in an appreciation of the rupee during most part of the year. However, large FII outflows and heavy dollar demand by oil companies led the rupee to depreciate during the last quarter of 2007-08.

Among major international currencies, between end-March 2007 and end-March 2008, while the rupee experienced an appreciation of 9 per cent against the U.S. dollar and 7.6 per cent against the British pound sterling, but depreciated by 7.8 per cent against the euro and 7.6 per cent against the Japanese yen.

Reflecting the somewhat increased volatility, the standard deviation (percentage change) of rupee-dollar exchange rate increased marginally from 0.27 during 2006-07 to 0.38 during 2007-08.

During 2008-09, the rupee continued the depreciating trend till July 2008, reflecting FII outflows, bearish stock market conditions, higher demand for dollars in the backdrop of rise in crude oil prices and elevated inflation.

Notwithstanding easing of international crude oil prices from the peak of about $147 a barrel in early July 2008 to around $65 a barrel by the third week of October 2008 and moderation in domestic wholesale price index (WPI)-based inflation rate from a peak of 12.9 per cent on August 2, 2008, to 11.1 per cent by October 11, 2008, the rupee continued to depreciate. The exchange rate of the rupee fell from 39.99 at end-March 2008 to 49.95 on October 24, 2008.

However in the later part of 2008, the rupee recorded its historical low of 50.58 a dollar, before appreciating to 48.58/60 on January 2, 2009.

OOMMEN A. NINAN

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