 "Shilpa Kumar")
The rupee has witnessed remarkable stability over recent months and its volatility is at multi-year lows. This is in sharp contrast to last year, when the dollar's strength amid the US Federal Reserve's quantitative easing tapering expectation led to sharp depreciation of the currencies of emerging markets, including the rupee. Currently, in spite of the dollar index strengthening from 80 to 84 since early July, the rupee has remained stable in the range of 59-61.
The improved outlook has come against the backdrop of three principal factors - bottoming out of the business cycle, continued improvement in the external sector outlook and the Reserve Bank of India's intervention policies.
On the domestic front, economic activity is showing signs of improvement, as evidenced by the sharp pick-up in gross domestic product in the first quarter of the current financial year. We expect this recovery to gain traction in the latter part of the year.
Second, on the external sector front, the outlook remains positive. The monthly trade data is tracking our current account deficit (CAD) expectation of $42 billion for the year and the recent fall in crude oil prices also bodes well for the economy. If crude prices were to remain at current levels, the CAD could be even lower, further aiding the rupee. Lower crude prices also help ease inflationary pressures, besides contributing to lowering of the fiscal deficit target, on account of lower fuel subsidies.
The optimism surrounding India is further reflected in the strong capital flows. India has so far received portfolio flows of $22 billion this financial year, of which $12 bn is in the debt segment and $10 bn in equity. Inflows in the equity segment are the result of a positive outlook surrounding the economy's growth prospects. Debt-related inflows reflect the positive carry vis-à-vis interest rates in the developed world and the reduced need to hedge currency risk, with stability in the rupee.
Third, RBI's efforts to garner foreign exchange reserves through active forex intervention has helped improve the import cover ratio to around eight months, besides ensuring the rupee trades at a level that is encouraging for exports.
On balance, stable macro fundamentals and policy support will provide underlying support to the currency. Having said that, some imminent global events have to be accounted for as well, to determine the rupee's short-term trajectory.
In the near term, the Scottish independence referendum, scheduled for Thursday, will be a key event to watch. The US Fed's policy meeting this week will be another. Both these are likely to cause volatility in the international financial markets, affecting the rupee.
The Fed's tightening bias over the medium term remains a key risk for financial markets, as this might result in a slowdown in capital inflows in emerging markets. However, we believe the rupee is relatively well prepared to weather this, as compared to last year. Its stability also reflects the fact that external financing needs have reduced and India's reliance on portfolio flows to finance the CAD has diminished considerably.
We believe the rupee is likely to trade in the range of 60-62 in the short to medium term. Though news flow from across the globe is likely to weigh on the domestic currency, resulting in intermittent spikes beyond the range, these are likely to be short-lived and the currency should revert toward the range in the medium term.
The author is senior general manager and head, global markets group, ICICI Bank
