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Where is the rupee headed?

May 10, 2004

May close year at 42.50/$

A Parthasarthy, Head-Trading, HDFC Bank Ltd

Where the rupee is heading? It's a million dollar question. And any reader's guess would be as good as any expert's.

The rupee has been appreciating against the dollar. The factors behind this are well known. There has been an unprecedented amount of forex inflows. The contributors to these inflows are private transfers and services exports on the current account, portfolio inflows and external commercial borrowings on the capital account.

These inflows have been much more than what could be absorbed by the foreign currency needs of our economy. So, a major part of these inflows have been absorbed by the Reserve Bank of India by purchasing the dollars from the open market. This has resulted in the country's forex reserves growing by about $40 billion during 2003-04.

In the first half of the year the rupee moved from 47.48 (March 31, 2003) to 45.78 (September 30, 2003) -- an appreciation of 3.58 per cent. During this period the reserves grew by $14 billion.

Between October 1 and March 18 last year, the rupee moved from 47.48 to 47.25 -- an appreciation of just 1.15 per cent. However, the inflow did not slow down during this period.

On the contrary, the reserves grew by around $20 billion during this period. During the first half, the RBI was constantly present in the market but allowed the rupee to appreciate in a calibrated manner. In the second half, it was present more aggressively almost as if holding on to an exchange rate level.

The real fun and games started post this period. On April 2, 2004, the rupee touched a high of 43.28 -- an appreciation of 4.35 per cent in just 14 days. The reserves grew by around $2.5 billion during this period, characterised by a very passive presence of the RBI in the market.

The rupee rate movement and the reserves growth during the period following 2 April seem paradoxical. The rupee depreciated against the dollar during this period and touched a low of 45.02 on May 3. It closed at 44.65 last week, a depreciation of around 2 per cent. During this period, the reserves grew by over $5 billion.

With the beginning of the new financial year, the RBI resumed its more aggressive stance of foreign currency purchases. With the introduction of the market stabilisation scheme, the central bank has adequate armoury to deal with the surplus liquidity. The aggressive intervention caused a shortage of dollar in the market.

How do we see the $/rupee exchange rate from here onwards?

The Indian economy, one of the faster growing economies in the world, will continue to see foreign exchange inflows much in excess of its requirements and hence the RBI will continue to intervene and purchase these from the market.

However, the quantum of such surpluses may not be as high as seen in the previous year. However, we could still see reserves accretion in excess of $20 billion.

The exchange rate is likely to be much more volatile than the previous year. The recent movements seem to indicate that the RBI may be tolerant of a higher volatility in the exchange rate. The rupee is likely to appreciate and we could see a level of 42.50 by the end of the financial year.

Stability at Centre is the key

Pawan Bajaj, Chief dealer, Forex, Bank of India

The outlook for rupee in the short term appears to be unsteady. A crucial factor could be the outcome of the elections in mid-May. It has the potential to impact the pace of economic reforms. Exit polls last week had sparked fears of a hung Parliament.

A slowing down of economic reforms due to political instability could hurt foreign investors' robust appetite for Indian equities and lead to a slowdown in capital inflows.

After touching a high of 43.27 per dollar on April 2, it weakened to 45.00 on May 3, underscoring the nervousness prevailing in the market. Concerns about the pace of foreign inflows, which have supported the rupee in the past two years and a drop in regional currencies against the dollar have also weighed on the rupee in the last two weeks.

Political uncertainty could mean that the rupee may follow a roller-coaster ride in the near future and following the formation of the new government, it may settle around 43.80-44.25 per dollar.

Recent US data show signs of recovery in the economy, which could lead to the Federal Reserve raising interest rates sooner than expected from a 46-year low of 1 per cent.

If that is the case, we may see the dollar strengthening against other majors and regional currencies. According to analysts, the rupee is still overvalued by nearly three per cent.

In such a scenario, we may not see a rapid appreciation of the local currency, which was the forecast before the general elections were announced.

To protect the interest of exporters, who felt the heat of the appreciating rupee, the regulator may not allow a significant strengthening.If the NDA comes to power, we may immediately witness a strengthening of the rupee to around 43.80 per dollar. In case of a hung Parliament, it can touch 45.50 levels.

We are optimistic about the medium-term growth outlook for India and infrastructure development and consumption are expected to increase.

The country is due for economic boom. The immediate worry is a stable government at the Centre that can steer economic reforms smoothly. In short, inflation, capital flows and politics are sources of mid-term uncertainty.

We presume that economic reforms will continue and whoever comes to power will be able to control the challenges. The outlook appears to be positive and the process of rupee strengthening will continue and we will witness large capital inflows to the Indian assets market, which we have been seeing in the last two years.

India's story is fundamentally strong with the key drivers being infrastructure spending, continuation of retail lending and more outsourcing opportunities.

With these assumptions in mind, the mid-term outlook for the rupee appears to be bright and we may witness its strengthening to 43/$ levels by the end of this year. The only worrying factors are the high fiscal deficit and increase in public debt.

Despite constraints, if the new government is able to iron out such drags, the outlook for the rupee will be more positive in the near future.

These are the author's personal views and not necessarily of the organisation he works for



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