Rupee in free-fall mode: It`s the sentiment

Rupee in free-fall mode: It's the sentiment

Last Updated: Tue, Jun 12, 2012 04:57 hrs
Cashier counts currency notes inside bank in Lucknow

The rupee has been mauled over the past few weeks, with the possibility of Greece exiting the Euro zone and the Spanish Armada hitting troubled waters. Along with the rupee, the euro and other emerging market currencies, too, have fallen against the dollar. But the rupee has been the biggest loser and has depreciated 5.75 per cent since the beginning of May.

This depreciation has not happened because anything fundamental has changed about India. MSCI India is up 4.5 per cent year-to-date and there's been no flight of capital so far. Also, the trade deficit has been steadily inching downwards from the $20-billion peak touched in October 2011. But, the rupee cost of imports remains higher year-on-year. So, the rupee does seem oversold, thanks to the negative sentiment surrounding India's weak macros and the inertia in New Delhi. Economists and market experts believe even after factoring in the twin deficits, the fair value of the rupee is close to 50-51 against the dollar.

So, what is dragging the rupee down? Espirito Santo's chief India economist, Deepali Bhargava, believes what started off as excessive demand for the dollar has become increasingly speculation-driven, with the majority of the market following a 'good news-sell INR/bad news-sell INR' modus operandi. The result was a self-fulfilling prophecy of lower rupee. However, Deutsche Bank's chief economist, Taimur Baig, and India economist Kaushik Das don't think the rupee is misaligned, as the current account has, of late, faced financing pressures.

Whatever the reason for the sharp fall, a consensus is emerging among economists and market experts that the currency might snap back on lower oil prices. Oil analysts expect Brent crude oil to average at $100/barrel in 2012 and at $115/barrel in 2013. Citi expects India's FY13 current account deficit to improve, albeit marginally, to $65.3 billion (3.5 per cent of gross domestic product, or GDP) against the estimated $74.3 billion (four per cent) in FY12. Despite the positive triggers, the rupee is expected to trade in the range of 55-56, as capital flows may remain weak. Deutsche Bank has forecast the rupee to be 10 per cent weaker in FY13, compared to FY12.

There is no doubt that the weak currency does have an impact on prices (a 10 per cent depreciation of the currency impacts the consumer price index by one per cent). Export competitiveness is a positive fallout of this currency volatility. Today, exports make up nearly a quarter of India's GDP. However, its contribution to growth has been negligible, thanks to rising imports. With the rupee falling substantially against most currencies, what will help India in the export market is its fall against the Chinese renminbi. This will give India a 30 per cent margin, which will either boost earnings of exporters or help them cut prices. Economists expect exports to positively contribute to GDP growth this year.

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