CRISIL Research has come out with its report on Rupee. According to the research firm, the rupee value is more sensitive to movements in the current account, a lower CAD in 2012-13 (aided by lower crude oil prices and dipping
gold imports) will help strengthen the rupee.
Rupee at 50 by March 2013
2/3 chance of Rs 50/USD
1/3 chance of Rs 55-57/USD
CRISIL Research, in the base case scenario, expects the rupee to appreciate from the current levels (Rs 56.3 per dollar as of June 29, 2012), to settle at around 50 per dollar by March-end 2013. We assign a two-in-three chance to this event. On the domestic front, the key underlying assumption is that the government will initiate some credible policy measures to revive growth, which will improve investor appetite. This would be accompanied by an easing of the current account deficit to 3.6 per cent of GDP in 2012-13 (from 4.2 per cent in the previous year) as global crude oil prices soften and gold imports decline. The base case forecast also assumes no further worsening of our expected growth (6.5%) and inflation (7.0%) scenario. On the global front, some improvement in the Eurozone situation towards the first quarter of 2013 is assumed. These factors should improve investor sentiments and stimulate the return of capital inflows. Improved risk appetite of the foreign investors would lead them to consider the opportunity India offers due to:
- Cheaper Indian assets due to correction in equity prices and a sharply depreciated rupee
- India’s interest rate differential with advanced countries
- Growth rate differential that India maintains with the West and the other emerging markets
- The new measures announced by the RBI on June 25, 2012 aimed at attracting foreign capital inflows
In the alternate scenario, CRISIL Research expects the rupee to settle at around the current levels of 55-57 per dollar by March-end 2013 and assigns a one-in-three chance to this event. This scenario assumes a status quo in domestic policy setting and no change in the Eurozone problems, with the ongoing global turbulence continuing. Although the pressure on current account will ease to some extent, due to lower global crude oil prices and declining gold imports, there could be an outflow of foreign capital, which will put pressure on the rupee. We however, regard the possibility of a situation akin to the Lehman crisis, wherein there are significant capital outflows, as a tail event.
Rupee movement an interplay of vulnerability and shocks
The rupee has witnessed substantial depreciation in the past one year. It nosedived again after the brief spell of appreciation in January and February 2012 (triggered by the sudden inflow of foreign capital as FIIs’ investment limit in government bonds neared expiry date). It fell by an average 11.3 per cent in June 2012, as compared to March and by almost 24.9 per cent on a year-on-year basis. The fall in the rupee is a stark reminder of the 2008-09 episode when the rupee had plunged to a low of 52.1 per dollar in March 2009 from 39.9 per dollar in April 2008. Our analysis below shows that vulnerability of the rupee to external shocks is higher in the current episode compared to 2008-09 (Table 1), when the impact of shocks was more pronounced.
Vulnerability of the economy is higher this time
The recent fall in the rupee can be attributed to domestic and global factors (Figure 1). However, the pressure has been more severe from the impact on current account (demand for dollars) rather than on the capital account (supply of dollars) (Figure 2). The capital account balance has declined over the past 4 quarters, though it remains in surplus. The current account deficit, however, has ballooned over this period. This has increased the unfunded part of the current account. Higher CAD means higher need of foreign financing which, in a fragile global environment with low risk appetite, is not forthcoming.
Conclusion
Strengthening of the rupee from current levels of Rs 56.3/USD towards our estimate of Rs 50/USD will require both, an improvement of capital inflows and lowering of the CAD. Recently (June 25, 2012), the RBI has taken some measures to attract capital inflows into the economy. For instance, the FII investment limit in government securities market was raised to US$ 20 billion from US$15 billion, while the residual maturity on such investments was reduced to 3 years from 5 years. To enhance liquidity in the market, the central bank has also allowed for an expansion of the permissible investor base to include sovereign wealth funds, multilateral agencies, endowment, insurance & pension funds, and foreign central banks. In the medium term, this move could facilitate foreign capital inflows. In the short term too, there could be some increase in foreign capital inflow because of the move to allow manufacturing and infrastructure companies to avail external commercial borrowings (ECBs) to repay rupee loans in the domestic banking system. Some other measures such as the proposed liberalisation of withholding tax on ECBs and easing of norms for foreign investment in infrastructure based mutual funds could also provide some temporary support to the rupee. However, given that the rupee value is more sensitive to movements in the current account, a lower CAD in 2012-13 (aided by lower crude oil prices and dipping gold imports) will help strengthen the rupee.
Disclaimer: CRISIL Research, a division of CRISIL Limited (CRISIL), has taken due care and caution in preparing this Report based on the information obtained by CRISIL from sources which it considers reliable (Data). However, CRISIL does not guarantee the accuracy, adequacy or completeness of the Data / Report and is not responsible for any errors or omissions or for the results obtained from the use of Data / Report. This Report is not a
recommendation to invest / disinvest in any company covered in the Report. CRISIL especially states that it has no financial liability whatsoever to the subscribers / users / transmitters / distributors of this Report. CRISIL Research operates independently of, and does not have access to information obtained by CRISIL’s Ratings Division / CRISIL Risk and Infrastructure Solutions Limited (CRIS), which may, in their regular operations, obtain information of a confidential nature. The views expressed in this Report are that of CRISIL Research and not of CRISIL’s Ratings Division / CRIS. No part of this Report may be published / reproduced in any form without CRISIL’s prior written approval.
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