How has the rupee performed?
After falling 2.6% against the dollar in 2016, the rupee is on a roll in 2017. In this calendar year, the rupee is one of the best performing Asian currencies which has strengthened 5.9% against the dollar. It is the best performing currency in Asia after the Thai Baht, the Singapore dollar, and the Taiwanese dollar. On August 4, when it touched 63.56 against the dollar, it was on a two-year high, since July 22, 2015. On Friday, August 11, however, it closed at 64.13 against the dollar on sustained demand from importers and corporates.
When did the turnaround begin?
Many currency experts said the Union Budget in which Finance Minister Arun Jaitley showed a resolve to stick to the path of fiscal discipline and the government’s thrust on reforms boosted investors’ confidence. The budget was followed by the monetary policy of the central bank which changed its stance from accommodative to neutral, indicating it wanted to keep inflation under check. This further boosted investor sentiment — as reflected in the rise of the equity indices — both Sensex and Nifty touching all-time highs in recent weeks, though there has been some correction in the last few weeks. Since February, portfolio capital flows were over $25 billion which boosted the rupee.
How are the authorities reacting?
For a long time, the sharp appreciation of the rupee was seen as a worry as it hurts exports. However, it seems there is a change in the thought process of the Narendra Modi-led NDA government. There were several comments from Union Minister of State (Independent Charge) for Commerce and Industry Nirmala Sitharaman which suggests the country may have developed a higher level of tolerance for the rupee’s upside. Ms. Sitharaman has suggested that the exchange rate is not the only factor for exports to grow. On its part, the central bank is not intervening in the foreign exchange now as it was doing a few years ago. The Reserve Bank of India always maintains that it intervenes in the foreign exchange market to curb volatility and does not target any level.
What is the worry?
One of the downside risks of the rupee’s recent rising spree is that a large part of the import portfolio is unhedged. Hedging would have helped companies with foreign currency exposure to shield themselves from fluctuations in rates. According to State Bank of India’s estimate, at least 40% of the importers’ portfolio is unhedged. In 2013, when the rupee was tumbling, the unhedged position of exporters was seen as a major worry for banks. Now, it is mandated that banks have to set aside capital, in terms of provision, if their corporate clients don’t hedge their portfolio.
“While rupee appreciation does have positive consequences in terms of lower imported inflation, in times of lower oil prices, we could perhaps live with a little bit of rupee depreciation,” said Soumya Kanti Ghosh, chief economist, State Bank of India. Mr. Ghosh also argued that with regard to trade with China, if the rupee continued to appreciate it could adversely impact the production of these domestic industries. The rupee also appreciated about 3.7% against the Chinese Renminbi since February. This has resulted in a surge in cheaper imports from China. “Even the IIP data reveal that industries such as electrical equipment; motor vehicles, trailers and semi-trailers; fabricated metal products; and chemical industries are showing negative growth in the past few months,” he said in a note.
What lies ahead?
While some correction is due for the currency in the near term, currency experts said trend in local stocks could guide the direction of the rupee. “Over this year, any correction in domestic equity beyond 2% from highs have triggered 1% sell-off in USD-INR,” Kotak Securities said in a note to investors. “At the same time, Nifty has not yet witnessed a 5% or more of correction since the intermediate rally began in December 2016, the longest streak in nearly two decades. Therefore, there is always scope that the correction could morph into something bigger than the 2-3% declines the market has witnessed in the past eight months. In USD-INR, as we remain structurally bearish, we would view a Nifty-led sell-off in INR as an opportunity to scale into positional longs in the high real yield pair,” it said.
