Expectations of rupee hitting 75 levels not unrealistic

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. The oil prices continue to rise, with sanctions looming over Iran and Venezuela being unable to maintain their production levels. Brent crude climbed to near $80 a barrel whereas WTI tested $70/ barrel last week. Oil was and will always be one of the major driving factors in determining the fate of rupee. 

Although, various other internal and external factors apart from oil are to be blamed for the fall in rupee.

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. With GST revenues undershooting the budgeted run rate of Rs 1.1 lakh crore will lead to fiscal deficit rising to 3.5-3.6% of GDP this financial year resulting in reduced investor confidence. So far this year, FPI have withdrawn Rs 6,700 crore and Rs 43,000 crore from equity and debt markets respectively. This is in stark contrast to Rs 1,64,000 crore of net inflows same time last year. There is also an outside possibility of government increasing spending in the run-up to general elections which may disturb the fiscal situation.

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. South Africa has recently slipped into recession with Russia rubble plunging on account of fears of looming sanctions. Year till date Turkish lira has depreciated by 63% against the US dollar, Argentine peso down 113%, Brazilian real down by 26% and South African down by 21% against the US dollar. Anxiety over the trade dispute between the world's two largest economies namely the US and China have resulted in dollar strengthening against emerging market currencies.

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. Despite the recent August CPI printing at 3.69% as against previous month's figure of 4.17% and below the RBI's target of 4%, there is a strong possibility of front-loading an interest rate hike of 25 basis points (bps) at the upcoming monetary policy meeting on October 5.

Apart from RBI FX intervention and interest rate hikes, there were market rumours of other measures such as turning to non-resident Indians to replenish FX reserves to the tune of $30-50 billion reintroductions of special swap window for oil marketing companies like it did in 2013.That would take a sizeable amount of dollar demand off-market and help stabilise the rupee. Alternatively, strong verbal intervention from RBI is also a lucrative option which the RBI has turned away from at least in the near term or relying on higher duties to restrict imports thereby reducing the current account deficit, as Indonesia recently did.

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. These include mandatory currency hedging for infrastructure loans to be reviewed and permitting manufacturing sector entities to avail of external commercial borrowing up to $50 million with a minimum maturity of one year. Removal of exposure limits of up to 20% of FPI corporate bond portfolio to a single corporate group, company and related entities and 50% of any issue of corporate bonds to be reviewed. 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. 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.

The writer is AVP, forex risk consulting, Mecklai Financial

TESTING LEVELS

• The rupee is expected to consolidate between 70.50-72.50 in the near term before testing new life-time high of 74-75 levels
   
• Recent measures announced by the govt may still fall short of market expectations