Why the rupee may lose steam versus US dollar

The rupee has been on a strong march versus the US dollar, breaking the technically-crucial 61 level Monday, closing at 60.85.

The currency closed at a seven-month high and has advanced 1.9 percent in only five trading sessions.

But according to experts, the rupee has run its appreciation course and may only reverse course going ahead.

The recent strength in the currency has primarily been driven by three factors: a sharp cut in the current account deficit, steps taken by the government and the central bank to attract capital flows and rising foreign interest in Indian equities and debt.

But at least two of three steps look set to have run their course.

“We expect the current account deficit to be 1.9 percent of GDP in FY14, before rising to 2.5-3.0 percent of GDP in FY15 as gold curbs are removed and domestic growth starts to recover,” brokerage firm Nomura said in its report.

Finance Minister P Chidambaram recently said the country’s current account deficit for the full year would be below USD 40 billion (or less than 2 percent of GDP), compared to USD 88 billion for the previous year.

Another key factor that helped strengthen the rupee was the temporary dollar swap facility announced by the RBI, which boosted foreign reserves to around USD 292 billion. “Given that the RBI temporary dollar swap facility has now expired, we don’t expect this magnitude of capital inflows to be sustained,” Goldman Sachs said in a note, while laying out a target of 65 for the rupee over the next 12 months.

According to CLSA, headwinds for the rupee ahead include rising non-gold and non-oil imports, a tightening liquidity environment externally, structurally high inflation within the economy and an expected easing of gold curbs.

The brokerage said it expects the currency will depreciate to 65-67 to the dollar by March 2015.

A Narendra Modi government at the Centre, which could result in greater FII flows in the Indian market, only marginally improves CLSA’s outlook for the currency, which then believes it to depreciate to around the 62-65 range.

For the near term trajector, a key event is the upcoming federal elections, Arvind Narayanan, Head of Sales – Treasury and Markets, DBS, told CNBC-TV18.

He added that ahead of the elections, the rupee may not break 60.20-60.30 on the higher said while on the lower side, 62.50 remains the floor.