Mumbai: The rupee may have appreciated more than the Reserve Bank of India (RBI) expected, according to market participants who anticipate increased intervention by the central bank to halt the currency’s climb.
At the close of of the fiscal year on 31 March, the rupee ended at 44.91 against the US dollar, just over 12% stronger than at the start of the fiscal.
RBI, in line with its stated policy, does not intervene in the market except in the case of a sudden currency fluctuation. On earlier occasions, RBI had let the rupee strengthen to about 39 against the dollar, as in 2007, when foreign institutional investors pumped $17.5 billion into stocks.
Graphic: Paras Jain / Mint
With the rupee just shy of 45 to a dollar, a crucial factor that could come into play is the real effective exchange rate (REER) of the Indian currency, which shows that it’s in the over-bought category and above the level at which RBI has typically intervened in the market.
The JPMorgan REER index for the rupee—which tracks its strength against a six-currency basket—is now at 112.34. According to market participants, RBI comes into the market when the index rises above the 105-106 level.
To be sure, the central bank has stayed away from intervening in the market until now. But predicting such action is difficult because the central bank operates through a clutch of public sector banks (PSBs).
Since RBI makes its currency trades public with a two-month lag, market participants try to guess its moves through the buying and selling tactics of these PSBs.
This time, though, RBI may have more fundamental reasons to intervene. The rupee has appreciated more than 15% from 52 to the dollar in March 2009. Taking into account the current inflation rate of 9.89% in February, the appreciation is close to 25%, notes A.V. Rajwade, a Mumbai-based independent foreign exchange consultant.
This erodes the country’s competitive advantage against other Asian economies, many of which bank on cheap exports to drive growth.
“I am very surprised why RBI is not coming in the market,” said Rajwade. “I understand other Asian currencies have also appreciated, but they run a current account surplus whereas we are having a huge current account deficit, which is growing.”
The most recent data from RBI shows India’s December quarter current account deficit at $12.03 billion (Rs54,255 crore today), compared with $11.94 billion and $6.39 billion at the end of the September and June quarters, respectively. The capital account surplus for the quarter ended December also fell to $14.73 billion.
According to Indranil Pan, chief economist at Kotak Mahindra Bank Ltd, since the capital account surplus was almost at par with the current account deficit, RBI may have stayed away from the market.
“The current account deficit and the capital account surplus in Q3 more or less matched, which explains the limited intervention of RBI in the currency markets in Q3 and also the relatively tight range of movement of the USD-INR,” Pan wrote in a research report after the 29 March release of balance of payments data by RBI.
Another likely reason for RBI’s current hands-off approach could be that a strong rupee pushes down import costs, which in turn, eases the pressure on inflation, currently a key concern of the central bank.
Last month, ahead of its scheduled April policy review, RBI unexpectedly increased key policy rates that it uses to infuse or drain liquidity by 25 basis points each in a bid to curb inflationary pressures and start a monetary tightening process that is expected to continue late into the year. One basis point is 0.01 percentage point.
“Inflation is a huge policy issue for RBI and intervening in the short-term would be contrary to that,” said Renu Kohli, a former economist at the International Monetary Fund. “But it is going to be a long appreciation and it makes sense that RBI do something about it.”
Though some Asian currencies have appreciated more than the rupee’s 12.02%—the Korean won rose 22.55% in fiscal 2010—those economies, some of which are large exporters, have much lower rates of inflation.
Not surprisingly, Indian exporters have started crying foul, with lobby groups such as the Federation of Indian Export Organisations writing to the government to have a fixed dollar/rupee rate for exports to be able to compete against other countries, primarily China, which has pegged its renminbi to the dollar.
Bilateral trade between India and China has also been rising, but has been skewed in the latter’s favour, with India’s trade deficit rising steadily to cross $23.14 billion in fiscal 2009, when India’s exports to China were $9 billion while imports from there hit $32 billion. The rupee’s continued rise against the euro has also hurt exporters to European countries.
“Nobody is talking about exporters in the Euro area. Last December, one euro was close to Rs70, now it is close to 60. Exporters in these regions are badly hit,” said Satyajit Kanjilal, chief executive officer of Forexserve, a currency consultant.
According to Rajwade, the Indian rupee should be allowed to depreciate 15-20% more to retain the country’s competitive advantage.
However, if China revalues its currency—which some Western governments have lately been calling for—India should not have a problem continuing with a strong currency, said Jamal Mecklai, CEO of Mecklai Financial and Commercial Services Ltd. According to him, the rupee is not going to strengthen dramatically from here although “there will be lot more volatility”.
Too much, too soon?
The Dollar Index, which measures the US unit’s performance against six major currencies, rose to 82.176 in the last week of March 2010 from 76.732 at the beginning of the fiscal year. In the same period, the rupee continued to strengthen, bar a blip in February, when it weakened to 46.81.
But market watchers say it might have peaked already.
“Every 10 paise appreciation from here will be a struggle for the rupee,” said Kanjilal, who expects it to appreciate in the short term but says it will fall to 47 per dollar in six months.
Mecklai expects the rupee to trade in the 43.50 to 46.50 a dollar range by December.
R.V.S. Sridhar, treasurer at Axis Bank Ltd, has an explanation for a possible depreciation of the rupee in the coming months.
“Too much of dependence on non-trade inflows is behind the appreciation of rupee,” he said. “We believe this is not a sustainable basis for the strength of the rupee as the trade balance continues to deteriorate.”
According to Sridhar, the rupee could go up to 44.60 level, but no higher in the coming months.
In a 30 March research report, HDFC Bank Ltd said the rupee would see a considerable two-way movement in the coming quarter. “While some more appreciation cannot be ruled out, we predict considerable two-way movement around the 45 mark. Thus, we seek a trading range of 44.20-45.50 over the next quarter,” the bank said, attributing the stabilisation to “fatigue”.
“If the pace of capital flows declines and the current account moves back to deficit (as historical seasonality suggests) then the appreciation momentum could dissipate,” the report said.
However, it also expects RBI to step in to curb some of the appreciation pressure as it is “concerned about currency competitiveness”, a possibility if the rupee begins to outperform the Asian currencies.
The most bullish on the Indian rupee, however, seem to be foreign banks and analysts who predict a continued rise of the currency.
Standard Chartered Plc said the rupee could appreciate to as much as 42 a dollar by December. “India will continue to attract capital and the fiscal situation looks healthy after the Budget,” said Ananth Narayan, head of rates and foreign exchange for South Asia at Standard Chartered.
A Reuters poll of fixed income strategists on Bric (Brazil, Russia, India and China) countries also showed the rupee strengthening to 43.53 against the dollar by March 2011, supported by buoyant growth in Asia’s third largest economy.
In its quarterly global fixed income report for March, Barclay’s Capital analysts Michael Gavin and Piero Ghezzi said that even as dollar weakness subsides in the coming quarters, emerging market currencies, especially those in Asia, will continue to rise.
While the bank is bullish on the rupee, it also expects “RBI’s focus to shift to REER strength in the medium term, limiting USD/INR appreciation”.
Domestic analysts, though, are quick to squelch such enthusiasm. “I don’t subscribe to these views,” said Sridhar of Axis Bank. “That kind of rapid movement doesn’t happen in the rupee.” As if to buttress his opinion, investors in offshore non-deliverable markets are betting that rupee will be around 45.50 level by the time the New Year comes around again.