Rupee hits 9-yr high: Will it appreciate further?

Nifty BSE | NSE 25/05/12 Are Mutual Funds betting on Nifty?

The rupee has been on an upward march and has appreciated further to 41.85 against US currency, thus touching nine-year highs, following sustained portfolio inflows amid absence of intervention of the central bank.

The main trigger for the dollar weakness has been the weak business sentiment in the US. The dollar fell on Monday against several currencies, including the pound, yen and euro.

The first tranche of the increased Cash Reserve Ratio (CRR) by the Reserve Bank of India has also caused a fresh liquidity constraint, leading to liquidation of dollars. The CRR was hiked in two tranches of 0.25 percentage points each, the first of which came into effect last Friday, while the second will kick in a fortnight later.

India's exports growth rate declined significantly to single digits from about 24% from last year due to the recent appreciation in rupee. But Finance Minister P Chidambaram is of the opinion that the rupee hasn't lost its sheen.

"I think the rupee still is very competitive compared to other currencies. There are other currencies, which have appreciated more. This appreciation is because of a large inflow of capital FDI, FII, export earning, remittances - which is good for the country - at currentlevels, I think it's still competitive," he adds.

Callum Henderson, Head of Currency Strategy of Standard Chartered Bank believes that the rupee rally will continue. In fact, he expects the rupee to touch the 41 mark over the next couple of weeks. But as inflation comes down, he expects the rupee to correct again.

Henderson attributes three main factors for the rupee rally, "Firstly, the Indian economic growth story remains quite strong and secondly, the RBI has continued a policy of gradual interest rate hikes. Also, We obviously had some seasonal tightness in the Indian money markets, which has caused the money market to sky rocket. So all these three factors are attracting capital into the Indian rupee and into the India local markets, which continue to push it higher."

Anand Krishnamurthy, Co-Head of Global Markets at HSBC believes that only an RBI move can stop the current rupee rally at this point. According to him, "The biggest dominant force on the rupee is the Reserve Bank and their activity in this market is going to determine how much the rupee appreciates from here on. By and large, the structure of flows seems to suggest that the supply of dollars is going to continue. But it's a function of at what level the central bank intervenes or at what level it doesn't become profitable anymore to sell dollars and the demand side takes over."

Krishnamurthy expects the rupee to test 41.5 in the near term.  He further adds, "Given the structure of flows and a very strong rupee, you can have a bigger move than this. But it can stop and reverse itself too and the movement is likely to be quite choppy with a lack of RBI intervention. You are going to see some volatility on the rupee."

Sean Callow, Senior Currency Strategist, Westpac Banking echoes the view that Central Bank's intervention could reverse the rupee rally. He also adds that they haven't changed their forecast for the rupee. "I think the speed of the decline in dollar versus rupee that would really draw the attention of the Central Bank. So at this point, we haven't changed our baseline forecast for the rupee. We have it just under 43 to the dollar by the end of June. We will be keeping an eye on the price section but at this stage we think it will probably stabilize in coming weeks."

Most dealers attribute this meteoric rise in the rupee to the RBI, which has been intervening less than it normally does in the forex market, probably because today inflation is a bigger concern than any other.

However, Professor at IGIDR, Dr Ajay Shah believes that when the central bank is more focussed on inflation and less on the currency, it is a good idea. But he feels that there is a need for more transparency from the central bank in terms of data. "We need a lot more central bank transparency and they should be giving us data everyday, about what currency trading they are doing. Secondly, it is useful and important for all exporters and importers to have access to a currency futures markets, so that people can do their own risk management."

But Dr Ajit Ranade, Chief Economist at AV Birla Group begs to differ. In his opinion,  using the currency to fight inflation by non-intervention is not a good idea. According to him, "If one looks at the macro-economic fundamentals, we expected the currency to actually depreciate, not appreciate - whether it is a fiscal deficit, whether it is a current account deficit, whether it is an inflationary situation in India and a variety of other factors. But the fact that the currency is strengthening because of the flows is just unprecedented and exporters are hurting like anything."

He further adds that it is difficult to manage currency and interest rates together and also difficult to look at inflation and currency together, but 10% appreciation in one year is totally unprecedented and even the import duties have come down to 7.5%, the peak rates are at 7.5%. So, this could be a double whammy to domestic positions.

By Surya Surendran (With CNBC-TV18 inputs)