Outlook: Indian rupee may hit 58 to US dollar, Narendra Modi set to be 'shackled'

Apr 03 2014, 14:56 IST
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Talks of the Federal Reserve taper have been more detrimental (given markets pricing in the event) than the actual taper as far as flows to the EMs are concerned. (Reuters) Talks of the Federal Reserve taper have been more detrimental (given markets pricing in the event) than the actual taper as far as flows to the EMs are concerned. (Reuters)
SummaryProbability of a favorable outcome in Lok Sabha elections still low: Kotak report

Positive sentiment from expectations of a favorable election outcome, following a sharp improvement in the CAD/BOP situation and increased capital flows through the swap window of the RBI, has put the Indian rupee on an appreciating bias against the US dollar. While it may be possible for the Indian rupee to move towards 58.0 against the US dollar in the near term, sustaining this strength may be difficult. We revise up our FY2015E average Indian rupee to US dollar rate to 61.0 from 63.0 but do not factor in any sustained structural appreciation bias yet. The RBI is also likely to continue buying FX to shore up its FX reserves to help restrain the appreciation bias.

#1: Essential to build up on the current import cover of 7-8 months

India’s import cover of ~7 months is low compared to long-term average of ~10 months (Exhibit 3). We note that the import cover during 2003-07 at ~14 months was higher than the long-term average. In CY2004-07, with capital flows being strong, the RBI bought Dollars at an average pace of ~US$2.5 bn every month, leading to an increase in FX reserves to US$275 bn from US$100 bn. Currently, FX reserve are at US$294 bn but might not be adequate if the extent of build-up of short-term external debt is also taken into consideration. Recent experience highlights that even small doses of nervousness can have a large contagion effect on EM economies, thereby requiring the RBI to accumulate FX reserves to provide stability to INR. Our BOP estimates indicate that there would be opportunity for the RBI to intervene and build up on the reserves in FY2015, effectively restricting the pace of USD/INR appreciation.

#2: ‘Known unknown’ of Fed policy by end-CY2014

Talks of the Federal Reserve taper have been more detrimental (given markets pricing in the event) than the actual taper as far as flows to the EMs are concerned. Assuming that the Federal Reserve continues with US$10 bn taper every month, the asset purchases will end by October. Beyond that, the pace of US recovery will determine the timing of the US policy interest rates moving up. Given Yellen’s press conference after the last policy meeting (and assuming ceteris paribus), risks on EM currencies will likely emerge once the interest rate hike expectations are back (likely in 3QFY15). This will also be much after the election phase in India when (hopefully) markets will focus

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