Mumbai: India’s widening trade gap may eclipse forex market sentiment in the near-term, but prospects of capital inflows and strong economic growth may keep the outlook for the rupee bright in the medium-to-long-term, a strategist at Standard Chartered Bank told Reuters on Wednesday.
The trade deficit edged back into double digits in April after averaging $9.1 billion in Q1 2010 and has remained elevated since then. Latest datashows the gap stood at $12.93 billion in July, highest since September 2008 and widening further from $10.55 billion in June.
“In the near-term, trade deficit financing concerns may continue to dominate the INR as the market debates the certainty of capital inflows in Indian markets,” Priyanka Chakravarty, forex strategist at the bank said in an interview.
“However, capital flows have already staged a smart recovery and we expect sustained inflows to eventually overwhelm trade deficit concerns,” she said.
The Indian rupee rose 4.7% in 2009, helped by record inflows of $17.5 billion into equities from overseas investors, but is down 0.8% this year despite $12.8 billion of inflows so far. “The key reason the large foreign institutional investor (FII) inflows have failed to trigger sustained INR appreciation is because the outlook for FII inflows has been very clouded,” Chakravarty said.
Recent worries about global growth have followed global sovereign risks and thus market participants are more comfortable playing a range on the rupee, rather than taking an outright appreciation view, she said.
The rupee was trading at Rs46.90 per dollar at 11:00am, up 0.4% on the day. Chakravarty expects the rupee to continue to trade in a range of Rs45.80 to Rs47.50 in the near-term and sees the unit at Rs47 to the dollar at end-September 2010.
Seen Stronger Going Ahead
Standard Chartered Bank expects the rupee to strengthen to 45.5 by end-2010 on the back of a strong economic outlook, a well-balanced monetary policy, lack of central bank intervention and an internal indicator suggesting a meaningful rally in risk in the fourth quarter of 2010.
“A key risk to this view is a greater-than-anticipated slowdown in global growth in the second half of 2010 which would significantly impact the outlook for capital flows and balance of payments,” Chakravarty said.
The Reserve Bank of India (RBI) , on its part, has refrained from intervening in the forex market for seven straight months until June, letting the currency find its way amid the globally uncertain markets.
This is despite the fact that the rupee’s real effective exchange rate (REER), or a measure showing its strength against a basket of currencies of its six trading partners adjusted for inflation, shows it was overvalued at 114.6 as on mid-July, according to the central bank’s data.
Chakravarty attributes this restraint to the fact that a large part of the REER valuation is on account of soaring inflation in India, unlike a similar situation in 2007 when the rupee rose on the back of large hot money inflows and prompted the central bank to intervene to check the unit’s sharp rise.
“Given the moderation in inflation expected going ahead the REER should also soften leaving the central bank comfortable with some nominal exchange rate appreciation,” she said.
India’s is the world’s second fastest expanding major economy and withgrowth expected to clock in around 8.5% in FY11 according to the government, economists expect the country to attract large foreign investor interest.
“From a long-term perspective India still is an attractive investment destination due to its growth potential,” Chakravarty said.
Some analysts expect rising interest rate differentials between India and the US to aid larger investment flows.
“Empirically the relationship between INR and interest rates is not significant, so I view interest rate differentials as one of the many factors contributing to INR appreciation, but not the driving force behind INR appreciation,” Chakravarty said.