Other than the general election outcome, and probably because of it, the hottest topic of speculation now is the rupee. Will it strengthen, go up to 54 to the dollar? Or crash, to 70, on a precipitous exit of foreign investors, unnerved at the prospect of a fractured political mandate, aggravated by a potential credit-rating downgrade?
First, a bit on the timelines of the view. Currency markets are the most difficult to predict. Nobody but a technical analyst or a currency trader will dare take a short-term view, and few but an intrepid economist or a George Soros will dare a long-term forecast. In the near-term, the rupee’s directions will be driven by circumstances that would seem binary. Animal spirits of foreign investors, in the event of a stable party or coalition at the Centre, will handsomely reward India and the rupee in the short-term, with the potential for a sharp and probably relatively brief spurt of appreciation.
After that, multiple factors, most notably macro fundamentals, will shape the direction of the rupee. The first, in current times, of course, is global economics. Overseas investors’ recently-discovered confidence in India’s potential caused its rapid exit from the erstwhile “Fragile Five” list. But despite the exuberance, concerns persist. RBI Governor has succinctly presented a formalised argument against the asymmetric balance of influence between advanced and emerging markets, particularly their central banks, on the impact of actions tantamount to a competitive devaluation of the their respective currencies. The result? Currency volatility is likely to persist as central banking actions across the globe play out.
Apart from policy actions, there is a strong rationale for the dollar to appreciate. The US economy is improving (despite the poor Q1 growth numbers) and the Fed is likely to complete the QE taper and raise rates much before the Eurozone and Japan. In the world of reduced dollar liquidity and a reduction of arbitrage potential, is India (and other emerging markets) likely to keep getting the quantum of foreign currency funds we have seen in the past few months (or in the heydays before the global financial crisis)? Yes, in the event of a stable government, there will probably be a transient spurt (or the reverse, under the alternative).
On the domestic front, drivers of India’s forex inflow and outflows have become more favourable in FY14. The good news is India’s ability to absorb foreign capital