India’s current account deficit (CAD), foreign fund inflows into the country and the amount of forex reserves it holds are among several factors that influence rupee stability. CAD or trade deficit occurs when a nation’s payments to other countries exceed the amount it receives. The Indian economy is heavily dependent on imports, particularly of oil and gold.
Payments to other countries are made in foreign currencies. As such, rupees have to be sold to make those payments and any surge in the sale of rupees leads to a fall in currency value. When foreigners invest in India, they sell dollars and buy rupees and therefore, higher inflows of foreign funds have a positive impact on the rupee’s valuation.
India’s central bank, the Reserve Bank of India (RBI), sells or buys dollars to control the rupee in a volatile environment. The dollars come from RBI’s reserves.
RBI’s forex reserve stands at about $15.5bn. A higher forex reserve gives the central bank greater powers to intervene in the market to control the rupee.
For FY14, India’s average CAD was 1.7% of the GDP as against 4.7% of the GDP in the previous fiscal — CAD dropped on a sharp contraction in imports, particularly gold imports. India’s CAD narrowed sharply to USD 1.2 billion (0.2% of GDP) in Q4FY14 from USD 18.1 billion (3.6% of GDP) in Q4FY13.
We expect CAD to rise gradually in FY15 to 2.6% of GDP due to a gradual increase in imports on better domestic demand as well as some relaxation in gold import restrictions by the new government.
The partially convertible rupee finished at 59.10/11 to the US dollar on May 30 as against 59.03/04 on May 29. For the week, the rupee shed 1% but gained 2% for the month as a whole. Rupee weakened on Friday after trading in a tight band for much of the session, as month-end dollar demand from oil importers offset large dollar inflows seen towards Yes Bank’s share sale. Earlier on Friday, RBI chief Raghuram Rajan said he expected to join hands with the country’s new government to bring down high inflation. He also said the new government’s plan to curb food inflation seems sensible and that he expected the public’s expectations on inflation would be met in future.
Rupee’s take on new government
The unprecedented mandate for Narendra Modi and expectations around his reforms and development agenda implies that the country’s growth story hope will remain strong, at least in the next few months. Rupee appreciation will most likely lead to lower inflation and less ambiguity. Fiscal deficit will be positively impacted by 20-30 bps, everything else remaining unchanged.
An RBI research stated that a 10% decline in rupee could add to 0.4-1.7% points to retail inflation in the long run and 2.9% points to headline inflation. The reverse may not be a mirror image but will be definitely moderate inflationary pressure, the research stated. More than 30% of WPI inflation can be classified as “important inflation” such as that in fuel, fertilizers, metals and machinery, and this portion will be positively impacted directly by rupee appreciation.
Indian rupee rallied against dollar, marking 2% gain MoM. Rupee tested high of 58.33 in spot last week of May, where it started with a low of 60.25. With one-year low of 68.80 and high of 52.9050, rupee has tested major resistance at 58.97 (61.8% retracement level). In the short term, RSI is indicating the pair to be oversold and it could bounce from here supported by formation of morning doji star pattern (bullish reversal pattern). We expect rupee to weaken further to a level of 60.86 for June and will continue to trade in the range of 58-61 in spot.
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