A Crystal Ball Gaze At Where The Indian Rupee Could Be Headed

Context: A complex interplay of factors makes the currency’s course hard to forecast, but trends do suggest a narrow near-term range.

Challenges in forecasting rupee value:

• Rapid rise in foreign exchange reserves: Giving an indication that India is getting in more dollars than we are spending, and hence our combined current and capital accounts are in the surplus zone.
  • India’s current account will go into deficit this year, and external commercial borrowings are to slow down (low investments)
  • However, strong capital inflows (At $60 billion in equity and $80 billion overall) indicate a stable rupee, with a tilt towards depreciation.
• Daily fluctuations caused by foreign portfolio investment (FPI) flows: US Fed’s recent indication that it would raise its policy rate of funds in years ahead was enough to strengthen the dollar and weaken the rupee.
• External factor of the dollar: When US currency strengthens against the euro, the rupee tends to decline and vice-versa. Given improving US growth, the dollar should be strengthening.
• Inflation and changes in the real effective exchange rate (REER): If inflation in India is higher than in countries associated with its export basket of currencies, then rupee is overvalued and will correct through depreciation.
  • This factor shall push rupee downwards, but the pressure will be less as global inflation is also being raised by rising commodity prices, and Indian inflation may not be so much high as to warrant a deep depreciation.
• Uncertainties regarding RBI intervention: RBI intervenes by buying or selling dollars to stabilise Indian currency when there is excess volatility, but what accounts for excess volatility is not defined.
  • RBI’s surplus liquidity and accommodative stance have not worked in favour of the rupee as low monetary policy rate when inflation and market borrowing by the government is high tend to push out investors.
  • However, managed bond yield curve and increased exports do help in neutralising this pressure.

Conclusion: Taking all these factors into account, one can foresee the rupee moving in the range of Rs 74-75 to the dollar, unless there’s a shock of some sort, though none looks likely at present.