Does the rupee appreciation matter? 10 things you should know
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The Indian rupee strengthened to 63.96 against the US dollar on Wednesday morning, a level last seen in August 2015. Does it matter? Here are 10 points to consider:
1. Chart 1 compares USD-INR to the Bloomberg JP Morgan Asia dollar index, a weighted index of 10 Asian currencies other than the yen. USD-INR has fallen much more than the Asia dollar index, which means the INR has strengthened more than its peers in Asia. That suggests reason for concern, from the point of view of the competitiveness of exporters.
2. Chart 2, from the IMF’s World Economic Outlook, shows that the real effective exchange rate of the Indian rupee has gone up much more than most other emerging market currencies.
3. The rupee has been appreciating because of strong capital inflows. These include portfolio inflows into equities and, more importantly, debt markets. They also include higher levels of foreign direct investment and instruments such as masala bonds. These are driven partly by global liquidity and partly by the improving fundamentals of the Indian economy. The Reserve Bank of India’s (RBI) relatively hawkish stance on the policy rate has attracted funds searching for yield.
4. For the RBI, what matters is the current account position, rather than just exports. The IMF projects India’s current account deficit at a comfortable 1.5% of GDP both for 2017-18 and 2018-19. Further, oil prices have also lost some ground lately.
5. Moreover, exports should also do well as global trade picks up. The IMF expects world trade volume in goods and services to grow by 3.8% this year, against a growth of 2.2% last year.
6. Earnings for the companies that make up the Nifty fall by 0.6% for every 1% appreciation in the rupee, according to a research note from UBS.
7. But this is offset by higher inflows trying to take advantage of the boost to returns provided by a stronger rupee. To illustrate, as on 25 April, the MSCI India equity index is up 12.97% in rupee terms, but up a much higher 19.28% in USD terms.
8. There is excess liquidity in the money markets, which makes the RBI reluctant to buy dollars. As IndusInd Bank chief economist Gaurav Kapur points out, “The cost of sterilization of capital inflows (through daily liquidity operations) is now going up, especially in light of the cost the central bank is already bearing to mop-up the excess liquidity in the banking system post demonetization.” In any case, a stronger rupee helps lower imported inflation. The RBI, as well as the government, seems willing to tolerate a stronger rupee.
9. The appreciation in the rupee has been steady, without much volatility. Exporters can always hedge their positions.
10. For all these reasons, so far there seem to be few reasons to worry about rupee appreciation, which reflects the improved fundamentals of the Indian economy.