Indian rupee plunge beyond most outlying expectations; further fall expected

The depreciation of the rupee has been beyond the most outlying expectations at the beginning of this year. While the valuations might suggest that the slide is overdone but global factors indicate that in the near-term rupee might come under further pressure.

The depreciation of the rupee has been beyond the most outlying expectations at the beginning of this year. While the valuations might suggest that the slide is overdone but global factors indicate that in the near-term rupee might come under further pressure.

While analysing if a currency has performed better than others or not, the biggest problem is that of selecting the time frame for comparison. The Indian rupee has depreciated the most among major emerging market (EM) currencies in the last one month and the most amongst the Asian majors this year. But if we look at a longer time frame like five years then the rupee is somewhere in the middle. The selection of base, therefore, makes it impossible to accurately comment on the right levels for a currency vis-a-vis the others.

Now if one adds the productivity differential of 2% per annum to the REER then the correct value for the rupee should be around 10% stronger or at 66 levels. The other way to explain this is that REER as a concept takes into account the regular import and exports of a country while it ignores the capital account.

India is a high growth country which attracts significant capital investments, therefore it is imperative that the same is taken into account while determining the right value of its currency. Given the two arguments above, it is logical to assume that the broad range for the dollar-rupee is between 66 and 73; therefore the current levels of 74 cannot be justified theoretically and can only be termed as a market adjustment.

Having said the above, we would still think that rupee in the short-term can come under further pressure as crude oil continues to trade near $85 levels and technically $90 seems a possibility.

The last week witnessed equity markets reacting to the sell-off in the rupee for the first time in many years which perhaps indicates that the depreciation of local currency has started worrying other asset classes as well. Consequently, the government’s and Reserve Bank of India’s (RBI) patience is also running out because of which we have seen a spate of measures aimed at facilitating capital account inflows into the country especially through the ECB route. But the fact remains that capital account inflows are difficult to come by when sentiments are unsupportive.

At this juncture, it is important for the authorities to introduce measures that would definitively reduce the net dollar demand from the market. This could be similar to an oil swap window wherein the OMCs get a direct supply of dollars needed for import payments from the RBI or something similar to the foreign currency deposit scheme of 2013. Any such scheme has its own complexities and costs which the authorities have to weigh carefully but as the rupee slides the chances of a major policy led intervention increases which can result in sharp two way movements. In the given context the rupee should trade in the range of 73 and 74.60 in the near-term.

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