Fed taper: rupee will be volatile but won't see a free fall yet

The inevitable has finally happened. The US Fed has started cutting its bond purchase by $10 billion to $75 billion a month. But the Indian market’s reaction to the decision has been muted. The stock markets declined, but it was not a freefall. The rupee’s depreciation against the dollar has also been not as sharp as feared.

The reason for this subdued response from the markets is that there was no surprise element in the US Fed’s action and statement. The market has already factored in a mild cut. Moreover, as Finance Minister P Chidambaram and RBI Governor Raghuram Rajan said, India is now better prepared for the taper.

But a section of experts still expect the rupee to stay volatile in the short term.

“We will have to wait and see how markets react to the first round of tapering,” says Andrew Holland, CEO, Ambit Investment Advisors, in a report in the Financial Express. He expects volatility in the forex market for the short term.

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[caption id=“attachment_1158277” align=“alignleft” width=“380”]  The reason for this subdued response from the markets is that there was no surprise element in the US Fed’s action and statement. The market has already factored in a mild cut. Reuters[/caption]

Many expect the currency to fall to 63-64 levels in the medium term, but rule out a repeat of the July-August depreciation.

“In the face of a stronger dollar globally and the structural CAD (current account deficit), we expect the rupee to depreciate versus the dollar but a repeat of the sharp move akin to July-September is unlikely,” Gautam Chhaochharia, head of India research, UBS Securities India, has told the Business Standard in an interview.

According to him there FOMC’s policy approach has little significance for Indian markets.

Moreover the authorities are better prepared now than in May to face the taper. The RBI has built a war chest of $34 billion through swap arrangements with banks. The government’s gold import curbs have brought down the current account deficit sharply. Current account deficit during the last quarter was 1.2 percent of GDP, way below the record high of 4.8 percent in the last financial year.

Also, the RBI has enough dollars to intervene in the forex market. There are reports that the central bank bought the rupee yesterday which helped it remain in a band of 62.12-62.48.

And to deal with any untoward rupee movement, it has one tool ready in its basket, a rate hike. After the policy review on Wednesday, Governor Rajan has warned that holding the rate does not mean that rate increase has been paused. Any spike in inflation is likely to force it into action on any non-policy day. A rate increase may not be meant to support the exchange rate (the RBI has always maintained so), but it will definitely help the rupee.