Mumbai: The Indian rupee closed within striking distance of its 2013 record low against the dollar on Wednesday as investors flee the risk of emerging market assets on expectations of a rate increase next month by the US Federal Reserve. With the Reserve Bank of India (RBI) unlikely to step in to shore up the rupee, given the global risk aversion and volatility, the currency is expected to weaken further.
A clutch of banks have revised their year-end forecasts for the rupee after the events of this month, including Donald Trump’s win in the US presidential race and the demonetization of high-value Indian banknotes. BNP Paribas, for instance, now expects the rupee to end the year at 68 per dollar, against an earlier forecast of 66.5. Deutsche Bank expects the currency to breach 70 by the end of December and 72.5 a year later.
“We think the case for further rupee depreciation remains in place, despite a constructive BoP (balance of payments) position. In our view, the scope of a more active US Federal Reserve in 2017 will help keep the USD (dollar) strengthening narrative intact,” said Deutsche Bank in a 22 November note.
On Wednesday, the rupee closed at 68.57 a dollar, down 0.45% from its previous close of 68.26, as foreign institutional investors (FIIs) switched money from local stocks and bonds to dollar assets. The rupee now is 28 paise, or 0.4%, short of its all-time low of 68.85 to the dollar. It has shed 2.61% in November. So far in November, FIIs have sold a combined $3.18 billion in local equity and debt, the steepest selling seen in three years.
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“This is the joint effect of the demonetization and the (Donald) Trump win in the US elections,” said Anindya Bannerjee, currency analyst at Kotak Securities Ltd.
While Trump’s likely expansionary fiscal policy has reinforced the case for a US interest rate hike in December, demonetization has affected both stocks and bonds. The withdrawal of Rs. 500 and Rs.2,000 bank notes, announced on 8 November, has dented the consumption growth story; consumer stocks were leading the rally till this happened.
FIIs have pulled out of bonds despite a massive bond rally because the yield differential between US and Indian 10-year government securities has fallen to about four percentage points.
“With a weak outlook for the rupee, it doesn’t make sense for foreign investors to invest at this kind of yield differential,” said Bannerjee.
Indeed, the rupee could have fallen more if not for the central bank’s intervention. Bloomberg reported on Wednesday that RBI probably sold dollars via state-run banks at least four times in the last fortnight, citing traders it didn’t name. RBI maintains that it intervenes to only smoothen any sharp volatility in the currency and not to support any particular level of the rupee.
The central bank “won’t prevent nominal depreciation of the rupee, especially when other EM (emerging market) currencies are depreciating”, said the Deutsche Bank note. “Allowing rupee to depreciate in line with other EM currencies will not only help maintain export competitiveness but also lead to a further easing of monetary conditions, which may be seen as necessary to offset risks to growth.”