Rupee to depreciate further: CLSA

The Indian economy is floundering, industrial output is down, inflation is rising, fiscal deficit is widening, policy paralysis is keeping investors on edge and the latest whammy the rupee has depreciated to an all-time low below 55 to a dollar.

Since July 2011, the rupee has fallen nearly 25%. CLSA says there is room for further depreciation, because the ongoing fall in the rupee is a correction to the significant appreciation in the Real Effective Exchange Rate (REER) seen since July 2009. It blames this primarily on the fact that RBI does not use REER as an important yardstick.

Global risk could easily result in ‘depreciating rupee to 57-60/$ in the near-term but it is likely to come back as conditions normalise.’

CLSA goes on to say that the current situation bears a striking resemblance to 1991 -- when India faced high global commodity prices, pressure from twin deficits, political uncertainty in the form of Rajiv Gandhi's assassination, loss of investor confidence, and dwindling capital flows. Then, of course, though India could approach the IMF for assistance, the key to India's rebound was path-breaking structural reforms enacted by then finance minister Manmohan Singh.

But a similar rebound might not be as easy this time, though Manmohan Singh is the Prime Minister. Given the current political logjam, reforms do not see the top priority as there is more talk but no action. Thus, the positive impact of ` depreciation will be limited.

CLSA adds that the effectiveness of RBI's unorthodox approach to correct economic imbalances viz-a-viz rupee or inflation is being diminished by the frequent self-goals scored by the government. But CLSA admits that RBI may still have an ace in the hole.

If needed, India could clampdown on gold imports and/or take recourse to issuing a global USD bond, similar in style to the Resurgent India Bond and India Millennium Bond in 1998 and 2000, respectively, or perhaps even a first-ever USD sovereign bond

Now, RBI has USD 292 billion in foreign reserves, including USD 26.6 billion in gold. This can comfortably finance 6.4 months of imports. Much better that the two-week buffer India enjoyed in 1991.

However, a weak rupee means the import cover is falling and with capital flows dwindling, RBI cannot sustain intervention to support the currency for long. So, a repeat of FY12, when it spent USD 20.2 billion on intervention alone, may not be possible this time.