Rupee at 9-month low and may be heading towards 70. Are you ready for such a change?

The Indian Rupee fell to a new low of 62.22 against the dollar yesterday, levels not seen since the beginning of the year. Is this part of a broader depreciation trend of the Rupee?

Rishad Manekia December 01, 2014 10:00:27 IST
Rupee at 9-month low and may be heading towards 70. Are you ready for such a change?

The Indian Rupee fell to a new low of 62.25 against the dollar this morning, levels not seen since the beginning of the year. Is this part of a broader depreciation trend of the Rupee? Lets examine some of the facts:

1. The Rupee is overvalued

A recent RBI Bulletin indicates that as per the real effective exchange rate (REER), the currency is overvalued by 6%. The REER index is trade-weighted, based on six currencies and indicates a higher inflation differential between India and its trading partners. The index shows a value of 106 for October 2014 compared to a value of 98 for the same time last year.

Even if we take a rough estimate of USD/INR at 61, it pegs the theoretical fair value of the currency at just under 65.

2. Other emerging market peers have depreciated

Despite announcements of tapering by the US Federal Reserve, the rupee has largely remained stable over the last year. This is due to a combination of factors such as a change in sentiment brought by the new government as well as timely interventions by the RBI.

These changes have created a large influx of foreign institutional flows over the last year that has enabled the rupee to perform far better than its peers. Other emerging markets have seen far more volatility in their currencies. As per RBI data, from January 1 to September 30, 2014, the rupee has marginally appreciated by 0.5% while other currencies have witnessed a depreciation. For example, the Russian Rouble by 16.9%, South African Rand by 7.4%, the Turkish Lira by 5.8% and the Brazilian Real by 3.4%.

A situation where these foreign flows start to slow or pull out due to change in sentiment will increase pressure on the currency. A lot of these factors, such as the US Fed tapering and a strengthening dollar, are outside the control of India.

3. Exporters need a weaker Rupee to stay competitive

It is very much in the interest of PM Modi's "Make in India" campaign to see the domestic currency weaken rather than strengthen.

Even though fundamentals of the economy are improving and inflation has been falling, it is against the backdrop of slow growth and deflationary conditions in developed markets, particularly in India's major trading partners. India is increasingly competing for slowing demand in major economies of the world such as Europe, Japan and China. Having a weaker currency would be an added advantage in pushing exports.

4. Indians love gold too much

Our love of the yellow metal is well known. Gold imports have risen 280% to $4.17 billion in October from $1.09 billion in the year-ago period. This surge has prompted the RBI and the government to relook at gold import curbs. These curbs can be effective only up to a point and will also encourage smuggling of the yellow metal.

India's trade deficit has been kept in check by falling oil imports, but this is unlikely to last if gold imports continue to surge. A weaker bias to the traded deficit will put pressure on the rupee to fall.

5. Structural depreciation bias of the Rupee over the long term

If we see the trend of the rupee against the dollar over the last 10 years, it has been one of steady depreciation.

Rupee at 9month low and may be heading towards 70 Are you ready for such a change

Source:XE.com

Even if PM Modi is able to take the Indian economy to new heights, the changes that are needed will take time to implement and are unlikely to lead to a significant structural reversal in the currency trend for the next year or two.

In light of this, it seems more likely that the rupee will touch 65 by the end of this year and possibly 70 before the end of next year. Are you sufficiently hedged against such a change?

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