Craig Chan, executive director and head of forex strategy & fixed income division (Asia-ex Japan), Nomura Singapore, in an interview with Rajesh Bhayani, shares his outlook on the dollar. He says if a convincing fiscal consolidation plan is presented in the Budget, the Reserve Bank of India (RBI) could get more freedom to cut rates. Edited excerpts:
We have seen a sharp fall in the rupee over the last six months and now, the rupee has appreciated sharply. Do you think the appreciation is over?
Recent measures by RBI like liberalising extra commercial borrowings, removing the cap on interest rates for deposits of non-resident Indians and measures to stem excess speculation in the forwards market has helped and inflows have resumed. Along with the RBI steps, policy responses by the Indian government were also positive, leading to a reversal of the weakness in the rupee.
In the coming Budget, if there is a convincing fiscal consolidation plan, RBI would have more freedom to cut rates. This type of policy coordination would be positive for attracting portfolio investment into the country and the rupee would certainly strengthen because of that. Nomura is still looking at the rupee standing at 47.2 against the dollar by the year-end.
Which risk factors can make the flow of portfolio money vulnerable?
The global backdrop remains a major driver and the importance of this is reflected in India’s financing gap. The main concerns from our financing gap analysis are equity outflows and short-term debt obligations, which may be $25 billion if there is a rollover rate of around 70 per cent. Add to this the large current account deficit, estimated at around $65 billion this year.
Another concern is the liquidity tightness from RBI’s dollar selling continuing and having an impact on the economy. This liquidity gap has been accounted for largely by the fall in currency reserves, adjusting for valuation and coupon effects. This data suggests RBI sold around $15 billion in spot and forwards.
These are just some of the factors that could pose risks to portfolio inflows. However, if this is followed by fiscal consolidation and rate cuts, which is likely, the local environment would be more conducive to capital inflows.
Any risk from the euro zone?
India’s vulnerability is still intact and would re-emerge if a phase of deleveraging/repatriation emer-ges from the euro zone. That said, if recession and deflation risks deepen in the euro zone, it is likely that the European Central Bank could go for full-blown, US style quantitative easing. From a global risk perspective, this would be positive for India.
What do you think of the rupee’s competitiveness vis-à-vis other currencies?
Looking from a trade-weighted perspective, our forex valuation analysis indicates the Indian currency is still around five per cent undervalued, even after considering the recent rally. This means it remains relatively competitive. The rupee is still around 11 per cent weaker against the dollar, compared to the lows seen around August. This has helped make Indian exports and portfolio investment into India more attractive.
How do you see the dollar performing in the near future?
Nomura expects the broad dollar to strengthen marginally through the second quarter this year. However, this is being led primarily by our view of the euro’s weakness. There could be some divergence in the euro’s performance against most of the G10 and emerging market currencies in the first half of the year because of negative idiosyncratic factors for the euro. These include capital flight out of euro zone fixed-income and growth underperformance. Through the second half of the year, the broad dollar weakness is expected to resume.
Do you see central banks globally acting in a coordinated manner?
When most other central banks in the region were easing their monetary policies a few months earlier, India was cautious, owing to high inflation. Now, with a cut in the CRR (cash reserve ratio), India has also indicated its easing bias. This has led to a convergence in policy with the region. But India is relatively late in changing its bias, though understandably, given the stickiness of headline and underlying inflation.