Indian rupee unlikely to strengthen immediately.
By R. Chandrasekaran
CHENNAI: In the past 10 days, the Indian currency has given all kinds of jitters to the policymakers, as the rupee hit a record low despite the government’s move to discourage gold imports. The question that currently haunts investors and non-resident Indians is whether the rupee will further weaken or will it get strengthened.
The fact that the high currency volatility may even force the Reserve Bank of India to keep the policy rates same and to avoid cutting down interest rates, when they meet on Monday, has further added apprehension about the rupee’s strength.
The weakening of rupee is not due to domestic factors alone and external factors have also contributed much to the slide. One of the primary reasons is a recent upgrade in rating of the United States by Standard & Poor’s to stable from negative to represent an improved outlook on both economic, as well as fiscal fronts. The rating change also suggests that in the next two years there is a less chance of a downgrade threat.
While the rating upgrade was a shot in the arm for the largest economy of the world, it has indirectly dealt a blow to currencies of the emerging markets. It has strengthened the U.S. dollar, which continues to remain the most favored currency despite all the tall talks about other currencies, especially the Euro, trying to replace the greenback in the world market, particularly in oil sector.
Although the latest rating change, which undoubtedly reinforced the faith on the U.S. dollar, impacted most emerging market currencies, rupee remained one of the worst hit.
When S&P downgraded the U.S. sovereign credit rating in August 2011, it had an impact on dollar in multiple ways. To begin with, money was shifted to commodity markets from the equity markets. This led the gold price to register a record high in September 2011. The oil price, too, remained at elevated levels for a long time. Both gold imports and oil price had its direct bearing on the current account deficit and the currency in the absence of matching exports, since the dollar outflow outnumbers considerably than the inflow. This impacted the Indian rupee unfavorably in the last few years.
The rupee hit a record low of Rs.58.98 on June 11, immediately after the S&P upgrade of the U.S. Though there has been considerable amount of inflow from foreign institutional investors until May, the scenario in June is totally different. The net outflow $905.3 million until June 13 is also one of the reasons for the sliding of rupee.
Aside from these, the yields on the U.S. bond is also increasing, making it a much safer investment in the face of global uncertainty and the doubts over the U.S. Federal Reserve’s continuation of the stimulus package. The higher yields on the U.S. bonds effectively limit the inflow of FIIs funds into Indian equity markets besides the growth concerns.
Till the close of May, there was a strong belief that the Indian currency might start strengthening at least by the September or December quarter, since there were enough indications of such a possibility. These included accelerated growth in exports following more incentives, curbs on gold imports, speedy clearance of projects by the Cabinet Committee on Investments — which enabled higher flow of dollar — oil price remaining at a relatively manageable level, and the reduction of interest rates to stimulate demand.
The slide of rupee has virtually ruled out the possibility of another 25 basis points reduction in interest rates when the RBI meets on Monday. The government is also trying to mop up more dollars by floating a separate bond issue for the NRIs. The policy makers believe that the current rupee weakening is more to do with the U.S. dollar’s strength and that more inflow will likely limit any further weakening of rupee.
Now analysts and experts have started reducing their target on rupee compared to their earlier estimation. For instance, Goldman Sachs has reportedly cut down its rupee outlook to 58 per dollar for the three and six month period from its earlier estimation of 55 to 53 for the same period. For the one year period, the brokerage reduced its target to 56 from 52.
It is quite clear that the rupee will not be able to strengthen at least in the near term or in the next three months. There are more downside risks in the immediate term. For the Indian currency to strength, the government has to come up with lot of measures to bring in dollar inflows, which seem unlikely in the current political scenario.