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Rupee V/S. Dollar Play

Monday, February 13, 2012

The rupee which witnessed a step fall through end 2011, recovered sharply from Rs. 54.5 to Rs. 49.5 in 2012 thanks to the increased FII and capital inflows. Today it is at the cross road and all eyes are on it, more so because it tends to impact every sector of the economy, directly or indirectly. The question now is: where is it headed? How will the rupee versus dollar play affect the economy through 2012? Manik K. Malakar does a ground check and forecast how the currency could behave over the year…

The Indian Rupee since the past month has been rising for both domestic as well as global reasons. However, the appreciation is a double edged sword. While our crude bill will certainly be assisted by the rising rupee, exports would suffer. But yes, one of the prime factors that will affect India’s rupee movements is our trade deficit and this may affect rupee appreciation.

“The current rally in the Indian Rupee is being driven by a number of factors that appear to be unfolding simultaneously both from the domestic front and from a substantial shift in global risk appetite,” says Abheek Barua, Chief Economist, HDFC Bank. Barua was speaking about the recent appreciation that saw the rupee reach Rs. 49.67 vis-à-vis the dollar in early trade on the Interbank Foreign Exchange Market on Friday.   

Barua notes that the initial turn of the rupee could be traced to the RBI decision to curb speculative trading in the forwards market and to de-regulate Non-resident deposit rates. This decision had two downstream effects. First speculation in the USD/INR pair was arrested and this helped the currency pair move into its natural equilibrium range.

Next the deregulation of the Non-Resident deposit rates helped in increasing fund flows from that source. “After announcing the measures, the RBI followed up by intervening more proactively in the FX markets so as to curb imported inflation pressures subsequently pushing the USD/INR pair lower,” says Barua.

So if India’s rupee appreciates who will cheer? “Primarily a stronger rupee will help to meet the commitment in dollar terms on import bills comfortably,” says K. Jayraman, Research Associate, Bonanza Portfolio. Remember that we import approximately 75% of our crude oil requirement and this is set to increase with GDP growth.

The other primary sectors that will be affected, both positively as well as negatively by the surging rupee would be exports and imports.

“There is a loose relationship between the trend in the rupee and the trend in exports,” says Shrikant Chouhan, Head, Technical Research, Kotak Securities. The Rupee appreciation would be a burden on exporters, but importers would benefit from an appreciating currency, as it reduces the cost of imports. However again there is a caveat. “Imports could surge if the currency maintains its appreciating path at a time when the domestic industry lags on competitiveness,” says Chouhan.

“In terms of imports, mainly crude oil, and for the equity markets too, a rupee appreciation is observed to be favourable,” says Milan Bavishi, Head Research, Inventure Growth and Securities.

And what specifically is the relationship of an appreciating rupee and India’s equities?
FII equity investments in January 2012 alone totaled more than Rs. 11,000 crore and in February 2012 more than Rs. 7000 crore have come in till date. They have also invested huge amounts in the debt market in December 2011 and January 2012. “In fact the rupee has appreciated from Rs. 54.5 to Rs. 49.5 only in January 2012 which is remarkable and which is directly relatable to the capital inflows” says Jayraman.

To the contrary, for the entire second half between July 2011 to December 2011 FII’s have been net sellers to the tune of Rs. 6700 crore, which has impacted the stability of the rupee and also the overall sentiment of the market. “Therefore the policy of the government should be to encourage investment and instill confidence on long term basis with FII’s so that they would be proactive in looking at opportunities in the Indian economy,” explains Jayraman.

However, Kotak Securities’ Chouhan is more sanguine. The “Appreciating rupee is an added gain for FIIs. However, FII flows are driven more by factors governing debt and equity markets.”

So at the end of the day is the appreciating rupee good or bad for the economy?
“A moderate staggered appreciation of rupee is a good sign of growth and best environment to expect. In the case of India, it is still a day dream as the outflow of foreign currencies towards commitments of the government and otherwise is ever increasing and because of the sound capital inflows we are in a position to manage the stability of the rupee,” notes Jayraman. A moderate strengthening of rupee against dollar over long periods is the most stable way for growth and development of our economy.

New Trends   
A key change that may be on the cards is the decoupling of the Euro and the Rupee. Decoupling is the breakdown in the correlation between two factors. So a decline in the Euro could accompany a rise in the Rupee. “The Euro could increasingly be driven by local factors including expansionary monetary policy and its dynamic need not reflect the global mood,” notes Abheek Barua, Chief Economist, HDFC Bank.

Currency Drivers

Currency and its stability is a complex issue which is driven by demand and supply on a day to day basis. “It is so sensitive that any abnormal economic activity globally or otherwise will have an immediate impact on the rupee against the dollar,” says K Jayraman-Research Associate-Bonanza Portfolo.

It requires a combination of factors like economic growth, fiscal deficit being under control, trade deficits and proper balance of payments, moderate inflation and sound policies of government. “Certainly the Indian government is doing its best and going forward 2012 will be a year of stability in currencies in a narrow range,” he continues.

Rupee range
Shrikant Chouhan, of Kotak Securities expects the rupee to trade in the Rs. 48 to Rs. 51 range in the H1 2012 period.

The rupee can still appreciate marginally from the current levels of Rs. 49.5 up to the Rs. 48 level in the next few weeks. However, if you take the H1 CY12 period the rupee can trade in a wider range depending on further capital inflows. Strikingly the rupee recovered sharply from Rs. 54.5 levels to Rs. 49.5 in January 2012, owing to FII inflows/ capital inflows on fresh allocation of funds to emerging markets particularly India during this year. - K Jayraman-Research Associate-Bonanza Portfolio.

“In H1 CY12, we could see volatility in the rupee/dollar. But we don’t see significant appreciation in the rupee from the current levels,” says Milan Bavishi, Head Research, Inventure Growth and Securities. “On the upper band dollar prices can rise again to Rs. 51.50. And the downside, we believe is limited to Rs. 48,” he concludes.

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