Rupee hits 64 again: Don't expect quick recovery, volatility will rule

The story of the rupee has been of a freefall since mid-May, which in numerical terms has meant crossing new psychological levels of 60/$, 65/$ and 67/$. An intra-day of close to 69 was also witnessed when we started speaking of a range of 70 and above.

Then suddenly, almost out of the blue, the rupee has started strengthening towards 63 and has been range bound at 63-64. Coincidentally this was also the time that the new RBI Governor took over. In fact between the 4 September and 12 September, the rupee has strengthened by Rs 3.60 as per the RBI reference rate. The market certainly appears to be enthused by the new Governor.

What exactly has happened in this span of one week?

The Governor definitely spoke confidently telling us that while the journey will be long, it will end well.

Three steps on the forex side were also taken. The first was to go back on some of the moves of RBI on outward remittances and FDI which happened technically before Rajan took over. It was called a clarification rather than a change. Second, a swap window was opened to get in more NRI funds, whereby banks could swap the same with the RBI at 3.5%. Third, the swap window with Japan was enhanced to $50 billion. These moves by themselves were not very significant, but showed a change in direction. All this while, the RBI’s measures were targeted at restricting outflow of dollars. These new measures, the latter two, were affirmative in nature as they were directed at getting in more dollars. This had a positive effect on domestic sentiment.

[caption id=“attachment_1106025” align=“alignleft” width=“380”] Exports have started picking up partly due to the rupee depreciation and partly due to increase in demand for textiles and engineering goods which are typically demand driven. Reuters[/caption]

The other reasons driving the rupee up were quite straight forward. On the side of fundamentals, our trade deficit has shown signs of improvement and though the data for August that reveals a lower trade deficit pertains to the month passed by, one can assume that the trend remains even in September. Exports have started picking up partly due to the rupee depreciation and partly due to increase in demand for textiles and engineering goods which are typically demand driven.

On the imports side, we have managed to rein in import of gold and hence the trade numbers look better. Add to this the fact that FIIs are looking at times more positively at our market, and we have seen some positive net inflows in the equity segment, which in turn has straightened the rupee to a certain extent. During 4-10 September, net FII inflows have been positive. It is not clear whether this sudden reversal is due to better valuations seen by the investors or their own faith in the new Governor (they were also positive on 30 August and 2 September when the change of guard had not taken place). Any which way, it has worked to turn the rupee around.

The global environment too looks a bit clearer and better for the currency, at least until the Fed meets on the 18 September. First, any unsatisfactory news in the US on the growth path is good news for the rupee. The employment numbers in the US do not appear to be improving which implies that it will take some time before the magic number of 7 percent is breached. This has been interpreted to mean that the withdrawal of the quantitative easing programme is still some distance away.

There are hence, hopes that this may not happen in September, in which case the Fed will choose not to roll back this time. This has been good news for the rupee, though admittedly, the issue is only being deferred for a while and it is only a matter of time before it happens. This also means that we can expect volatility to prevail for some more time.

Second, the fears of the USA attacking Syria have also ebbed for the time being which means that the turmoil in the geo-political space will be muted, again for the time being. The fear of a war had put pressure on oil prices, which have retracted since then. This appears to be good news for the rupee which has been able to breathe better for some more time.

What does all this tell us? Quite clearly, the role of sentiment has been quite decisive in pushing the rupee first down and then up. The variation between 63-69 has been sharp and while there have been some fundamentals working at times, such as net foreign inflows, the general tendency has been largely stable. Sentiment has caused these wide swings in the rupee and given that we are working hard to control the import of gold and hence our trade deficit, there is reason to believe that the fundamentals would probably justify an exchange rate closer to Rs 60/$. Deviations from this number would be sentiment driven and could also pick up on news from the west.

The market probably expects that Dr Rajan would not look at controlling outflows of dollars and probably concentrate more on getting in more foreign currency, which by itself should help the sentiment improve. But we also know that the US economy has to show improvement at some point of time and the 7% unemployment number will be reached. Also the expectations of a withdrawal are more unsettling than the actual withdrawal.

Therefore, on the whole, the rupee will remain volatile for more time now, which is the big negative from the story unveiled so far. Unless the RBI drastically goes back on the earlier invoked liquidity tightening measures, or starts lowering interest rates, which again does not look probable presently. The rupee cannot recover sharply due to just positive sentiment. Therefore a range of 60-65, which is quite vast, looks pragmatic until the next round of Fed conjectures come in.

The writer is chief economist at CARE Ratings and all views expressed in the column are personal.