‘In the light of the reforms to attract foreign funds, the pressure on rupee is going to ease’

The widening current account deficit (CAD) and uncertain political situation in the country may weaken the rupee further against the U.S. dollar this financial year.

The rupee closed 2012-13 at 54.28 a dollar. It touched a low of 55.15 on March 4, 2013. “The volatility in the market continues to be high on account of uncertainties in the international markets and worries over political instability in the country,” according to K. N. Dey, Director, Basix Forex.

The third quarter CAD of 6.7 per cent has added pressure on the government to announce fresh measures to attract large capital flows. It widened from 5.4 per cent in the second quarter of 2012-13 to a record high of 6.7 per cent of gross domestic product (GDP) in the third quarter, driven mainly by larger trade deficit.

In the short- and medium-term, the rupee is likely to be hampered by underlying structural budget and current account deficit with little scope for significant gains. According to Mr. Dey, the rupee is likely to move in the range of 53.50-57.50 a dollar in the next six months.

Widening CAD

“Widening CAD will adversely impact the value of rupee as the local currency will be dumped by foreign investors in the wake of flagging trade balance, slowing economic growth and an environment of policy inaction,” says Sugandha Sachdeva, Incharge-Metals, Energy & Currency Research, Religare Commodities Limited.

There is a silver lining, however. Although the CAD is large, it has been fully financed without drawing upon the foreign exchange reserves.

With the CAD at a record high, the Indian currency will be susceptible to a sudden reversal of flows, and, as a consequence, the recent real effective exchange rate appreciation could worsen the underlying imbalance.

Government reforms

However, Ms. Sachdeva says “In the light of the reforms and steps taken by the government to attract foreign funds such as issuance of NRI bonds and hiking FII debt limits, the current pressure, which is suppressing the rupee, is definitely going to ease.” “Government’s decision to hike import duty on gold, which is likely to slash the yellow metal’s imports, will also bring down the deficit,” she adds.

For nearly two years now, developments in Europe such as high debts, large deficits, and poor growth prospects have raised concerns over the fiscal sustainability of the region and, consequently, led to sharply higher sovereign borrowing costs.

Crisis in Europe

Uncertainty in Europe will make investors to look for safe investment options, particularly the U.S. dollar. This flight of funds will result in appreciation of the U.S. dollar against other currencies.

Says Ms. Sachdeva, “as the crisis in Europe deepens, it will contract the European markets and their demand of goods and services from India (including IT outsourcing) will slow down. It will result in lower exports from India, which, in turn, will lead to a further widening of the current account deficit,t indirectly putting pressure on our rupee.”

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