There was a time when taking a view on the rupee was relatively simple. Any discussion on the currency generally had a consensus on the direction of its move. At most, the disagreements used to be on the degree of movement.
A look at the Bloomberg forecasts of 31 banks for the rupee in the January-March quarter highlights the current rupee conundrum: analysts have pegged the USD/INR at 50 to 57! So, the only thing most people agree about now is that there will be volatility.
India remains a current account deficit country (the rupee will depreciate as we import more). But this is balanced by capital flows into the country (which supports the rupee appreciation). These capital flows are normally bulky and critically dependent on two things: the global risk situation and the Indian policy environment. The balance between the deficit and capital flows generally decides which way the rupee trends, and the size of the balance determines the strength of the move.
In trying to determine the near-term rupee view, we could build a likely scenario involving these two drivers of the country's currency balance.
Current account deficit: This had peaked to 5.4 per cent of gross domestio product (GDP) for Q2 of FY2013, from 4.2 per cent in FY2012 but is unlikely to increase much more on account of two key reasons. First, the government action on controlling key imports like gold and encouraging exports. Recently, a number of measures have been announced to boost exports, such as the extension of the interest subvention scheme on the rupee export credit, incentives for incremental exports to the EU, the US and other Asians countries and more avenues for availing export finance. Second, the price of oil, a determinant for roughly one third of our imports, is also expected to stay benign.
Capital flows: The global risk situation generally determines whether money will move at all towards emerging markets, be it in equity or in debt. Currently, this seems to be supportive of such flows and in fact, benefiting from the continuing supply of liquidity from central bankers in the developed world. In such an environment, money is flowing to emerging markets both through the bond and equity routes.
So, why would capital flows continue to be directed towards India? The government's action on key macro and policy issues has given comfort to global investors. Reduction of fuel subsidies through price hikes has been good news for the country's fiscal and rating profile. Opening foreign direct investment in airlines and retailing would mean significant investment in the country by international businesses. And, these reflections of resolve by the government would be applauded by FIIs, who would bring in more equity flows. The Budget statement in February would be closely watched, as further evidence of this fiscal prudence and reform orientation.
This is the scenario which supports our view that in the near term, the rupee seems to be in appreciation territory and headed for the 52-53 a dollar range. The backdrop of global risk and abundant liquidity supports this view. But, it is the government's macro and policy actions that are driving flows inward and ultimately the critical factor in determining the rupee's direction.