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Rupee freefall: Here are five things you may want to know

The rupee hit a fresh record low of 52.38 to the dollar on Thursday, and there is nothing to suggest that the free fall will end any time soon. Dipankar Mitra of brokerage house Motilal Oswal in his report addresses five key questions relating to the slide in the currency:

May 25, 2012 / 08:09 AM IST

Moneycontrol Bureau


The rupee hit a fresh record low of 56.38 to the dollar on Thursday, and there is nothing to suggest that the free fall will end any time soon. Dipankar Mitra of brokerage house Motilal Oswal in his report addresses five key questions relating to the slide in the currency:


Q. How did we land up here?


Currency movement merely reflects BoP situation: The INR (Indian rupee) depreciation can be traced to the worsening Balance of Payments (BoP) situation. In particular, the trade gap has grown rapidly since July 2011 when export growth slowed down below import growth. The invisibles surplus and capital flows have not been growing for the 3-4 years, leaving the trade gap open, resulting in BoP deficit in 3QFY12.


Q. Does it look like a crisis?


Yes… but not quite so: The INR has lost a quarter of its value since July 2011 and the CAD-GDP ratio is at 4%-close to the levels seen in countries affected by the East Asian crisis and higher than the 3% level of crisis hit India of 1991. However, there are important differences - import cover, external debt to GDP, and debt service ratio are at more comfortable levels now.


Q. What's the ammunition left?


Forex reserves, India resilience, lady luck: India has ammunition left to deal with any unfolding crisis. First, its formidable forex reserves are adequate by any definition of adequacy. Second is the proven ability of Indian manufacturing to withstand perhaps one of the most drastic tariff cuts in the last two decades (twice that of China). Third, India's ability to absorb shocks has increased in a globalized world, where private autonomous capital flows act as a countervailing force to weaknesses on trade account. Fourth - a much higher stake of foreigners, with cumulative value of FDI and FII exceeding 35% of GDP, when sensitized with a 10% CAGR return. Finally, as luck has it, flows between FDI and FII have altered, keeping overall capital inflows stable.


Q. What can the authorities do?


A policy dilemma: Policy choices are limited at this juncture. While allowing greater volatility in recent episodes, RBI concentrated on relaxing capital controls while discouraging speculation through administrative measures. Policy dilemmas include; i) while depreciation helps to restore trade balance, it complicates capital flows, ii) moreover, intervention has consequences on liquidity and conduct of monetary policy, iii) on its part government needs to come up with appropriate trade policy and pacts to correct the trade gap.


Q. Where next?


We see INR at 52 in FY13 and at 50 in FY14: As we see it, INR at 56 is at its long-term par value of competitiveness, as revealed in the REER measure that has come back to nearly 100. Further correction in the nominal Rupee would be an instance of overshooting. Moreover, price and demand conditions in gold and oil hold the potential to take the CAD/GDP ratio to as low as 1.5% from the current 4%. We see the INR averaging at 52/USD in FY13 and improving to 50/USD in FY14 (+/- 5% in both cases).


Also read:


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first published: May 24, 2012 03:53 pm

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