Rupee continues to fall in anticipation of budget proposals

Last Updated: Tue, Mar 05, 2013 10:10 hrs

The Rupee closed Thursday in heavy trading at 54.5, recording its largest one-day fall in over a month and a half. A similar sell-off was recorded in the Indian stock market, as shares plummeted to their lowest levels in seven months.

The Rupee had been on a strengthening bull run over the past several months, due primarily to inflows of capital from foreign markets, but recent drops have raised concerns that these favorable equity inflows are beginning to reverse. The global economic recovery in Western countries has been weak of late, causing investors to reconsider risk-based investments, especially those in developing countries. Both China and India have ratcheted back their respective economies in the past year due to weak demand from the West, but apparently the bottom may yet to be reached.

Trading volumes, however, were thin, as investors pondered the impacts of the latest nationwide strike and what government officials might propose in next week’s budget submission. Sudarshan Bhat, chief foreign exchange dealer at Corporation Bank, said, “The fall in the rupee on Thursday was a reflection of the stock market. However, I expect some bunched-up dollar inflows on Friday due to the ongoing strike.”

The following currency chart tells the recent story:

Currency experts believe the Rupee has reached an appropriate valuation and will continue to range about the 54.5 territory, roughly the average exchange rate for the past three months. Finance Minister P. Chidambaram will submit his budget plan next week. Will it focus on more government spending or will it rely more on fiscal discipline, as the market is expecting? If investors like what they hear, equity markets and the Rupee could reverse directions once again.

From a fundamental perspective, the RBI has set its interest rate benchmark at 7.75%, partially to curb inflation, but also to provide adequate incentive for foreign investors to invest in domestic offerings. GDP growth rates in India, however, have declined significantly in response to weaker demand from Western countries, dropping from an annualized figure of 8.9% to 5.3% for the last 24 months. While these growth rates may have fallen, developed countries are having difficulty reaching a 2% level, while a few major economies are slipping once again into recession.

As a result of these economic realities, capital has flowed out of India to safe havens, like precious metals and U.S. treasury securities. The Rupee, once at 44 to the greenback, has weakened to 57, a 30% change in value, but a reversal of fortune occurred over the past quarter.

Exports have been improving, but the trade gap in January broadened by some $20 billion, the second highest widening ever recorded. N.S. Venkatesh, treasurer at IDBI Bank, believes that, “Despite exports having improved, the high trade deficit remains a worry and will keep the rupee under pressure. If the government announces a pro-growth budget with emphasis on reforms, the rupee may gain to 52. Until then I see the rupee holding in a 53.50 to 54.10 range.”

The good news is that India’s inflation rate has been moderating, dropping down to its lowest level in three years. Since the monetary policy of the RBI appears to be producing results, the government may be more open to stimulating the current economic environment. Pressure from rating agencies, however, weighs heavy on policymakers. Insiders believe that government spending may be cut by another 10% to appease these agencies, an austerity measure that might send the wrong message.

Even with these ongoing debates and uncertainty, analysts are still predicting a strong year for the Rupee, settling in the 53 region for 2013.

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