Editorial: Modi impact on Rupee

May 16 2014, 04:12 IST
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SummaryCan’t afford to let it strengthen too much

Thanks to some relentless buying by foreign investors in bond and equity markets over the past few months, the R has risen a remarkable 4.5% since mid-February. At 59.29 to the dollar on Thursday, the R continues to outperform peers in the Fragile Five. If a Modi government comes to power, the belief is the R will move up to levels of 57-58. Much of this is predicated on FIIs remaining bullish on Indian markets—since mid-February, they’ve bought $8.6 billion worth of stocks and bonds. In the short run, the R could well surge to those levels, but it is likely to retreat thereafter. For one, while RBI may not explicitly express its views on where the R should be trading, the central bank’s commentary suggests it concurs with the finance ministry's view that 60-62 is reasonable. Given the Fed is tapering and that India has received its fair share of foreign capital, relative to peers, it is likely portfolio flows will taper off to let the fundamentals of the economy catch up with valuations. So far in 2014, roughly $7 billion has moved into India compared with just $3.3 billion into Brazil and $3.14 billion into Indonesia.

But should flows not peter out, RBI will want to shore up reserves, currently close to $300 billion and between 7.5 and 8 months of import cover. While the $32 billion that flowed in through the special FCNR(B) swap scheme last September has helped boost reserves, and the central bank has been buying dollars in the currency markets too, its objective would be to build up reserves to 10 months import cover.

Also, once growth picks up, so will imports. While gold imports will rise once restrictions are lifted, coal/iron-ore imports going back to earlier levels will put pressure on the current account and hence the rupee. Though a weak rupee is generally seen as a means to stimulate exports, it has to be remembered that it will take more than this to overcome India’s lack of competitiveness in sectors like textiles and readymade garments.

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