Rupee expected to test 75 levels in medium term

After witnessing a stable and strong rupee through most of last year, this year has been exactly the opposite resulting in rupee is one of the worst emerging market currencies this year. So far this year rupee has depreciated by 12% against 6% appreciation seen last year. Rupee at around 72 seems to be chasing oil price.

India has seen its current account deficit (CAD) widen to 2.4% in the April-June quarter from 1.9%. in the previous quarter. Economists expect the CAD to widen to 2.7-2.8% this year on the back of an increase in import of electronic goods and rising oil prices.

Turmoil in emerging market (EM) currencies like Argentine peso and Turkish lira has resulted in contagion fears among EM currencies reminding investors of 1997 Asain crisis.

The Reserve Bank of India (RBI) has tried to stem the tide by selling dollars and buying rupees. The foreign exchange reserves stood at $400bn in August as compared to $424bn just four months earlier. However, outright FX intervention by RBI has proven ineffective to stem rupee’s slide and it does not make sense to utilise the hard-earned reserves at a time when the rupee was overvalued as per REER model.

Fast forwarding to measures recently announced following an economic review meeting chaired by Prime minister Narendra Modi late Friday includes six key steps aimed at reducing the CAD and increasing foreign exchange inflows. Withholding tax on masala bonds to be scrapped for issuances in the current fiscal year. 

Removal of restrictions on Indian banks’ market making in Masala Bonds, including restrictions on underwriting of such bonds. The government said it will look to boost exports and curb non-essential import items that could face heat are mobiles, electronics and gold on which the announcement is to be done by related ministries. Subhash Garg said the measures announced on Friday would have an impact of about $8-10 billion dollars.

To cut a long story short, although the recent measures announced by the government will be welcomed by markets but may still fall short of market expectations such as the introduction of special swap window for oil marketing companies or issuing bonds to non-resident Indians.

It seems that the government may want to wait before introducing such measures or use it when rupee depreciates further to 74-75 levels. With the deteriorating domestic factors such as CAD on account of high oil prices, fiscal deficit on account of lower GST collections, political instability arising out of upcoming state and union elections and external factors such as rising protectionism leading to a full-blown trade war, rising US interest rates, stretched equity valuations may lead to weaker rupee in the medium term. 

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The rupee is expected to consolidate between 70.50-72.50 in the near term before testing new lifetime high of 74-75 levels in the medium term.

By: Ritesh Bhansali
(The writer is AVP, forex risk consulting, Mecklai Financial)

Source: DNA Money