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Rupee will hit 60 versus US dollar on worsening pitch; weakening Asian currencies trigger concerns

The rupee may depreciate 10% versus US dollar as weakness in other Asian currencies converges with India's fragile external economy.

Updated: Apr 12, 2013, 07.10 AM IST
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MUMBAI: The Indian rupee may depreciate 10% versus the US dollar by December as weakness in other Asian currencies converges with India's fragile external economy and a snail-paced recovery in industrial activity to pummel the currency.

At least five top currency traders and economists say the probability of the rupee falling to 60 to the US dollar is higher than it moving towards 50 with record foreign fund flows of the last eight months tapering off. This is largely on account of the boost in sentiment following a rash of reforms failing to translate into real business activity.

For the first time in five months, foreign investors are showing fatigue, selling equities for six days on the trot after investing a record $26 billion in stocks and bonds since September after P Chidambaram returned to lead the finance ministry.

"The flows in equities have already come in," said Ashish Vaidya, head of fixed income and currency trading at Swiss bank UBS. "If these flows reverse, the rupee could be further under pressure. I can see the rupee going down to 58-60 per dollar by the year end. With general elections due in a year, we are unlikely to see any change in the business environment."

The Indian rupee may get caught in the tsunami of Asian currencies' depreciation.

Vulnerable to Shocks

This is seen as an immediate trigger for the changing outlook as the new Bank of Japan Governor Haruhiko Kuroda's ultra-loose monetary policy strengthens the US dollar across all regional currencies, including the Japanese yen, which is down 20% in the last few months.

Asian currencies are depreciating led by the yen as the new administration tries to revive a two-decade moribund economy by flooding the market with cheap money. Since most Asian economies are competing for the same export markets and the view on the US dollar is positive due to signs of revival there, currencies such as the South Korean Won and Taiwanese dollar have also fallen.

"Even though the fundamentals don't necessarily warrant it, there is a perception that the yen's weakness would induce more generalised Asian currency weakness," said Sajjid Chinoy, senior South Asia economist at JPMorgan. "If this materialises, the rupee is also likely to come under pressure."

Depreciation of currencies across the region and an elevated inflation in India make the Indian rupee more vulnerable to shocks. Soaring prices in India and benign inflation in China make Indian products uncompetitive in the global markets.

"If India is going to have structurally higher inflation than its trading partners, the medium-term structural bias of the currency will have to be towards depreciation, for the economy to stay competitive," says Chinoy. " 60 (to the USD), therefore, seems much more plausible than 50 in the medium term."

The rupee is down 5.3% since September despite record foreign fund flows as the country imported far more than what it exported. That pushed the current account deficit - the excess of consumption overseas than earnings - to a record high of 6.7% of the gross domestic product, provoking a warning from the finance minister himself. The rupee ended at 54.52 on Wednesday. Its all-time low was 57.15 on June 22 last year, Bloomberg data shows.
 
Chidambaram's return led to liberalisation of foreign direct investment in multi-brand retail and aviation and raised the limit on foreigners' investment in Indian bonds.

To fund the CAD, he raised foreigners' investment ceiling in government bonds by $5 billion to $25 billion, and in corporate bonds by a similar amount to $50 billion, lifting the total cap to $75 billion. Withholding tax was cut to 5% from 20% on overseas borrowings and auction of permits to buy corporate bonds was scrapped.

A sticky inflation, as supply failed to keep pace with the demand induced by government splurge on welfare and subsidies on fuel, has made the economy fragile. Although the Wholesale Price Index has begun to ease after three years, consumer prices remain at double digits.

The negative real interest rates (where rate of return from banks is lower than inflation) worsened the CAD as people imported gold as a hedge.

But some believe that the worst may be over. The March quarter CAD is forecast at around 5.5% of GDP, though it is higher than the 2.5% the Reserve Bank of India says is sustainable. Barring external shocks, the rupee could be in range, they say.

"If our house view is correct, that current account has seen the worst, the rupee may not go all the way to 60," said Samiran Chakraborty, head, India research, Standard Chartered Bank.

"That is our base view. But then again, there are multiple risks to that, like if current account does not improve, if growth remains weak, or if political uncertainty leads to a pullout of funds, or if there is a big blowout in Europe. But our base view for the rupee is 53-56 per dollar."

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