BENGALURU: A strong US dollar and likely intervention by the Reserve Bank of India (RBI) is going to put downward pressure on the Indian rupee till the end of 2016.
“India is recognised as a positive medium-term story, however consensus expects the rupee to gradually depreciate until end-2016. This view is driven by expectations of dollar strength and the belief that the Reserve Bank will continue to intervene aggressively (buying US dollars) in the forex market,” Japanese brokerage Nomura said in a note.
It expects spot dollar/rupee at 63.2 by end of the third quarter of 2016.
These expectations, when combined with a world of beggar-thy-neighbour policies, concerns over the US over-valuation and its impact on the country’s export competitiveness, have resulted in a broad view that the RBI has a preference for a weaker rupee, it said.
The rupee does not appear significantly overvalued, with a marginal over-valuation of just 0.5 per cent. While current rupee valuations based on purchasing power parity (PPP) and real effective exchange rate (REER) models indicate some over-valuation, fundamental equilibrium exchange rate (FEER) model shows that the rupee is undervalued, it said.
Although REER appreciation has been blamed for recent contraction in exports, which stood at negative 16 per cent in first half of 2015, Nomura said the weak global demand, lower export prices, weak agriculture production and bottlenecks in the minerals sector were also responsible.
The note said the primary reason behind the RBI’s FX intervention has been a desire to build a buffer against potential external shocks. On this metric, the external vulnerability indicators have improved sharply, a large portion of the current account deficit is now financed by stable FDI inflows and there is a greater domestic macro stability, it said.
“The reserve accumulation of USD 105.85 billion since March 2014 appears sufficient to cover a full reversal of US QE-related inflows,” the note said.
Stating forex intervention is not without costs, Nomura said, “Although the benefits of higher reserves have so far outweighed the costs, we believe that the costs – both fiscal and the risk to monetary policy autonomy – may rise, which would call for a less interventionist approach, especially once the risks from an external shock dissipate,” the note said.
It said forex intervention should slow over time, however, it is still expected to remain an important driver of liquidity creation.
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