Where is the Rupee heading?

Economics
The rupee has been falling of late raising questions as to where will it eventually go. The rupee has depreciated from Rs 54.33 per dollar on April 2nd 2013 to Rs 57.78 per dollar on June 10th 2013 (also crossed 58 mark towards the end of the day), exhibiting increase in daily annualized volatility from 5.44% in April to 8% in May to 13.07% in June. Why is the Rupee falling? Table 1 Exchange Rate and Forex Reserve Months March April May Source: RBI Rs/ $ Average rate 54.40 54.38 55.01 Change in Forex reserves ($ bn) 1.50 4.30 -5.52

June 10, 2013

Besides sentiment, which is difficult to quantify, the exchange rate is driven by basic forces of demand and supply for foreign exchange or dollars. Data on foreign exchange rate is available on a daily basis but the factors that influence this rate come with different periodicity. The global exchange rates and FII inflows, which are major factors that affect the movement, are available on a daily basis. Other fundamentals that affect the exchange rate such as forex reserves, trade balance are available on a weekly and monthly basis respectively. The fundamental driving the rupee movement is ultimately the change in foreign exchange reserves decline in the forex reserves would result in depreciation of the currency. Foreign currency assets after increasing in the months of March and April 2013 declined to $ 258.50 billion in May 2013. The factors that drive the fundamentals are mentioned below The trade balance The trade deficit for April FY14 was estimated at $ 178 bn which was higher than the deficit of $ 140 bn in April FY13 and $ 98 bn in March 2013. Exports were $ 242 bn as against $ 238 bn registering a growth of 1.68% while imports at $ 420 bn, increasing by 10.96%. However, oil imports during the period grew by 3.92%. With increasing trade deficit figures, the fundamentals still appear to be weak pointing towards rupee depreciation. It may be expected that the trade balance has been under pressure in May and June too considering that the RBI and Government have voiced increasing concern over the import of gold and announced measures such as credit for gold purchases or higher duty to control the demand for the metal.

Economics
FII movement FIIs (Foreign Institutional investors) are showing some disinterest in Indian markets lately. Sluggish economy and recovery in stock markets of developed economies like US and Japan are believed to be the key reasons. Net FII investments have been in the negative territory ($ 1.45 bn) for the month of June (been negative on all trading days), has added pressure to the falling rupee in recent times. This is primarily due to net outflows in debt while equity inflows were positive. In April it was $1.99 bn and May was $ 5.7 bn. Global Factors Table 2: Currency units per $ (2013) Emerging Markets Russia Brazil South Korea Mexico Source: Economist May 1st 31.00 2.00 1,101 12.20 June 5th 32.10 2.14 1,116 12.80

The USD has been generally stable vis--vis the euro. From $ 1.31 in the beginning of May, it strengthened to $ 1.28 on the 28th before slipping back to $ 1.32 to a euro by the 7th of June. However, the USD has been strengthening against the currencies of a number of emerging market economies. This is mainly owing to the expectation of the Federal Reserve discontinuing the QE3 programme sooner, resulting in fewer funds flowing down to the emerging markets. Also, the ECB and the Bank of England maintained key interest rates at the same level. This would also provide for strengthening of the dollar. Domestic Factors Current Account Deficit: FY13 has been a year of sustained pressure on CAD, which settled at 5.4% in the first nine months. The government continues to target gold as a way to reduce the current account deficit. Certain policy actions such as increase in the duty on gold imports to 8% and restriction on loans provided by the banks to buy gold could help in decreasing the countrys gold imports. Sentiments: The sentiments are mainly affected by RBIs actions. The RBI can directly intervene in the forex market to curb falling exchange rate through dollar selling. The RBI has not intervened so far, however it has expressed concerns over the volatility in the exchange rate. At the same time it has mentioned that it is not targeting any exchange rate. However, the market is looking at a target which is driving sentiment.

Where is the Rupee heading?

Economics
How has the rupee behaved in the past? Table 3 Average Exchange Rate Month Rate (average of month) March 2011 44.99 May 2011 44.90 December 2011 52.67 March 2012 50.32 June 2012 56.03 March 2013 54.40 May 2013 55.01 Source: RBI The rupee has been under pressure in the past too especially in FY12 when it had slid sharply between March and December by 17% before recovering by 4.5% in March 2013. The RBI had sold $ 20.14 bn during this year. In FY13, the rupee declined after the announcement of the Budget when there was apprehension over GAAR and retrospective taxation, which took the rate down 11.36% in June, before a clarification came from the government. The rupee subsequently closed at 54.40 a recovery of around 3%. The RBI had sold $ 2.6 bn in FY13. RBI intervention was lower this year when the point to point depreciation was 8.1% (11.8% in FY12). Going Forward The exchange rate movement would largely depend a lot on when the sentiments improve, which is guided by the FII flows and the RBI action. The RBI has spoken about the volatility of the rupee indicative of a possible course of action. The rupee touched the 58 mark today and it may be expected to stabilize once the RBI comes in the market. Till then the rupee would continue with the volatile movement in the market. Even when the rupee stabilizes, it would at a higher level than the band of Rs 54-56 which has been the range in FY13. The band could be in range of 55-58 with 56 serving as a signpost.

Contact: Madan Sabnavis Chief Economist madan.sabnavis@careratings.com 91-022-67543489

Anuja Jaripatke Shah Associate Economist anuja.jaripatke@careratings.com 91-022-67543552

Disclaimer This report is prepared by the Economics Division of Credit Analysis & Research Limited [CARE]. CARE has taken utmost care to ensure accuracy and objectivity while developing this report based on information available in public domain. However, neither the accuracy nor completeness of information contained in this report is guaranteed. CARE is not responsible for any errors or omissions in analysis/inferences/views or for results obtained from the use of information contained in this report and especially states that CARE (including all divisions) has no financial liability whatsoever to the user of this report.

Where is the Rupee heading?