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Rupee to settle in groove after recent falls

The rupee, which hit record lows earlier this week, should now be more stable, but will gradually depreciate over the next six months to align with its real or trade-weighted value, analysts said.

They said the rupee is currently overvalued by about 3.5 per cent against its five major trading partners, and expect it to fall to 48.0-48.5 per dollar by December.

On Tuesday, the rupee hit a record low of 47.21 per dollar, dragged down by an unexpected surge in importer demand which was exacerbated by a slowdown in dollar inflows, particularly from foreign funds.

It later recovered on suspected central bank intervention to close at 47.12/13. The rupee ended Wednesday at 47.10/11.

Traders said the rupee's fall was inevitable, given it had traded steady so far this year while other currencies were dropping against a strong dollar.

In the first half of the year, the rupee fell just one per cent against the dollar. In contrast, the yen has fallen more than eight per cent so far this year.

The rupee weakened seven per cent in the whole of 2000.

"Basically, it is the demand-supply game," said Indranil Pan, associate vice president at Kotak Mahindra Capital Company.

"Import figures have been soft in the current year, while inflows particularly from foreign funds are strong which has kept the rupee from slipping despite an overvaluation," Pan said.

Foreign fund investments in India have been sharply higher than in the previous year while imports have been sluggish, reflecting an economic slowdown.

In 2000-01 (April-March), the current account deficit shrank to $2.26 billion from $4.7 billion a year earlier. With growth seen sluggish this year as well, a sharp reversal is unlikely.

CALIBRATED DEPRECIATION

India has favoured a calibrated depreciation of its currency rather than sharp purely market-driven adjustment, which could overshoot the target and depress investor sentiment.

The central bank has often stepped in to temper volatility in the market while allowing the rupee to depreciate gradually.

Oil prices have softened to around $25 per barrel from around $30 in June, which will limit pressures on India's import bill.

Portfolio inflows totalled $2.46 billion so far this calendar compared with $1.56 billion through 2000, although they have dwindled from $908.8 million in January to $240.1 million in June.

"This is the only negative thing going for the rupee," a currency analyst said, adding that changes in stock market rules and a crisis facing the country's largest asset manager, the Unit Trust of India, could see them holding back for a while.

But after the dust settles, they could return to the market.

"Capital inflows should remain strong simply because foreign funds have nowhere else to go," Pan said, adding that India could be preferred to other emerging economies, partly because of its stable currency.

Reserves stood at $43.278 billion, a rise over $3 billion so far in the calendar, and gives the central bank ammunition to intervene.

With such comfortable reserves, state-run oil firms, which account for a major part of the country's petroleum sector, can also directly buy dollars central bank to pay for their imports.

As Finance Minister Yashwant Sinha said on Tuesday in New Delhi, "The foreign exchange situation is absolutely under control. We are sitting on $43 billion of reserves."

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