Dollar/Rupee made a sharp U-turn mid-day as rumours of “policy driven” devaluation made rounds in media outlets. We find little substance in the news as Rupee remains a market driven exchange rate, and unlike currencies which are pegged, like Chinese Yuan, it is not easy to devalue or appreciate a currency as per the whims and fancies of the policymakers. At most a central bank can intervene in the FX market and buy US Dollars to devalue the Rupee for sometime but unless market forces are convinced it will be hard to maintain the currency on that path for longer time frame. At the same time here are the following reason why we believe India would not adopt a relative weaker exchange policy:
1) Import intensity of our exports have increased over the years. A weaker currency would also have a adverse impact on our exports which have import intensity.
2) Indian government is looking to make Masala Bonds popular. In this case it is the foreign investor who assumes the currency risk as the instrument is issued in local currency. If Rupee begins to depreciate sharply then foreigners may start demanding a higher coupon on these bonds which cause issuers to shy away.
3) India needs a stable currency to allow foreign investors to pour long term money into India. A weak currency is detrimental to such flows.
4) Indian economy is supply constrained making is inherently inflationary. Too weak a currency can cause inflation to rise. Higher inflation would lead to exodus of foreign capital into our bond market and impair the investments of the banks who are already strained
5) Indian government can face geo-political flak if it adopts currency devaluation as an overt policy.
The author is currency analyst, Kotak Securities.