Steady rupee delivers mixed bag of gains

In the past six months, the Malaysian ringgit has risen 9.8 per cent against the dollar, the South African rand has risen 11.4 per cent, but rupee has strengthened only 0.9 per cent. That makes it one of the most stable currencies in the region or in emerging markets, and one of the worst performers, too. The underperformance is perhaps good news for the export sector, as the country’s competitiveness edges forward, but considering India is an oil-importing country, a stronger dollar helps contain inflation.

Other emerging market (EM) currencies have rallied as the US government is now tacitly approving a weak dollar. This will have varied implications for India, in terms of its attractiveness as a market to foreign investors, and thereby inflows, inflation, exports, and imports. The dollar was already under pressure since November last year. Last week, US Treasury Secretary Steven Mnuchin endorsed a weaker dollar, stating it would be favourable for exports of the largest economy in the world.

The dollar index, which measures its strength against major currencies, fell below 89, a three-year low on Friday. Predictably, euro rose to a three-year high, while the yen rose to a four-month high against the dollar. The dollar index hit a low of 88.4380 after Mnuchin’s comments against its 52-week high of 102.26. In a year, the fall in index has been more than 11 per cent. On Monday, the dollar recovered some of its strength, but the index is still below 90, while the consensus is that it would fall in the coming days.

All EM currencies, at least those directly competing with India to attract foreign investment, have strengthened against the dollar in the past six months. The rupee has remained a laggard in this regard.

The reason for the rupee’s relative sluggishness is rising oil prices. However, a correction in overvalued rupee was long overdue. The real effective exchange rate (REER) of rupee continued to remain high but should cool down against the trading partners as they strengthen, whereas the rupee remained relatively stable. “While the rupee has strengthened against the dollar, it has actually weakened against euro, pound, and other currencies. Overall, our REER, on a 36-currency basis, has remained at the 118-121 range for a while now,” said Ananth Narayan, senior currency market observer.

The dollar weakness though, is good news for emerging markets, especially India as a weak dollar would bring more foreign funds to Indian equities and, depending upon the space availability, in debt. In the current fiscal year so far, foreign investors have poured in about $19 billion in domestic debt segment, almost exhausting their limits in government and corporate bonds. When overseas investors invest in India, they worry about currency depreciation risk which may not be there when dollar is projected to remain weak.

Nigam Arora, a US-based fund advisor and author of Arora Report, said, “India is a secular growth story. Domestic growth will continue. If rupee becomes slightly stronger, it will help control inflation without raising interest rates. We are advising US investors to look at India after a bounce in dollar index from its three-year low, due to dollar’s oversold condition.” Arora also sees Indian equities to be in overbought condition.

This means, at every correction in Indian equities, and with dollar remaining weak, funds from US should pour into India. “With Indian currency strengthening or even remaining stable more funds would flow to Indian equities and debt,” said Nirmal Jain, chairman of IIFL Group.

A stable currency in invested market eliminates the risk of currency risk, and if the currency appreciates, the investor gains.

However, the increasing flows, and a stable currency has potentially increased the risk in the financial system as most of the money are unhedged.

“Standalone, we do have a problem of growing unhedged exposures in USDINR. The foreign currency purchases by the RBI during this fiscal year cannot be accounted by permanent flows of CAD, FDI and FPI in equity — in fact, oil prices have driven our CAD to a fiveyear high this year,” Ananth Narayan said.

“Instead, we have seen substantial carry seeking inflows from FPI in debt, exporter selling, NRE (non-resident external) deposits and speculative positions. These are vulnerable to reversal if we see any global or domestic negative shocks,” Narayan said.