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Economy Aug 29, 2013

Rupee pull back to 66 semblance of stability, do not rule out 70

By Rajesh Pandathil

After an extremely rough ride for the last few weeks, the rupee today strong today at 66.92 and moved higher to 67.37 against the dollar.

The stock markets are also heaving a sigh of relief. The Sensex at 18,197.91, up 1.1 percent and Nifty at 5,340.55,up 1 percent.

But is this a time to rejoice? Not really. But there is no denying the fact that there is a semblance of stability returning.

Experts have largely attributed today's rise in the currency to the RBI's move to directly sell dollars to oil marketing companies.

AFP

AFP

The central bank yesterday said it will, with immediate effect, open a special window for oil companies to buy dollars directly from it. According to reports, the companies can now buy dollars from a designated bank. The oil companies are the biggest dollar buyers in the market as India imports about 80 percent of its oil requirements.

Now with only one bank selling dollars to these companies, the bidding for dollars will come down to that extent, which will in turn limit the demand-led push on the dollar.

Another reason for the pull back is that most of rupee's recent fall was sentiment-driven. The swift moves of the rupee from 64 to 68.8 points to this fact.

However, this, again, is temporary and one cannot rule out the rupee going back to 70 levels.

For one, there is no stopping the demand for dollars. Foreign institutional investors want to pull their money out of emerging markets, including India, so that they can invest in the US once the Fed starts unwinding its accommodative policy. The Fed has not yet said clearly when it will begin the so-called tapering of quantitative easing. There have been only indications and the FIIs have already started fleeing India. So once the actual event takes place, the capital flight will be even higher.

Add to this the fresh geo-political tension in the Middle East, which has pushed the crude oil prices to near $120 per barrel levels. Media reports say that even if the US finally decides to go to war with Syria, it is unlikely to be a long and protracted one. So the crude prices may not go back to the $140-150 levels. But India's situation now is such that even a small pinch from a minor price increase is felt harder. With India importing 80 percent of its oil needs, oil companies will need more dollars. The RBI's move to sell dollars to oil companies directly will only bring down the volatility in the exchange not the demand as such. In short, we ain't seen any dollar demand yet. As the demand for the dollar goes up, the rupee's depreciation will continue.

The authorities have devised policies to attract FDI flows, of which a large chunk is quick fix aimed at making the markets happy. The long-term steps will take time to bring about the intended benefits. For example, the FDI measures. For these to result in dollar flows, it would take at least two years. The simple reason for this is that India is in election mode and no sensible multinational would want to invest here ahead of an impending uncertainty.

Moreover, in the event of the rupee again falling to 70 or lower, the RBI may not be able to defend the currency much, because there is not much left in its forex reserves. If the dollars are used up to fight the rupee rout, the government will be forced to approach the International Monetary Fund for a loan and the UPA will have to pay a price politically. So, even if the RBI is willing to go to IMF, the government would not want it. It will instead prefer pricier options such as NRI bonds and deposits.

True, current account deficit may surprise. Trade deficit has already come down. But if the West Asia developments are likely to hold the rupee hostage. All in all, the relief that we see now is not because there is any major change in the fundamentals. A move towards 70 cannot be ruled out.

"...Current account deficit in Indonesia and India are definitely the candidates here for any major selloff or shocking events and at the same time Indonesia, Malaysia, India and also Thailand have seen historically high levels of inflows into bonds and equities from the impact of QE. So, these are vulnerable in the event of a capital portfolio outflows," Christy Tan, director, Asian Forex Strategy, Bank of America Merrill Lycnh told CNBC-TV18 yesterday.

by Rajesh Pandathil

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