Re may gain even as current account deficit widens

Even as the current account deficit widened during the first quarter and the Real Effective Exchange Rate (REER) indicated the rupee is overvalued and should weaken, strategists and exporters predict the rupee may continue to gain on inflows.

The rupee has gained 3.4 per cent since January 1, trading at 44.95 per dollar, while the REER was 111.24 in mid-August, according to the Reserve Bank of India (RBI) data. (See graph)

Nomura Financial Advisory and Securities estimates the current account deficit as a percentage of GDP at 3.7 per cent, compared to 2.9 per cent in the year ended March.

“Next quarter, we expect the current account deficit to widen further,’’ said Nomura India Economist Sonal Varma. “Flows are strong and this is what matters for the currency. We expect the rupee to gain to 43.8 to a dollar by March 2011.’’

The main reason for the rupee and some other emerging market currencies to gain is a weakening dollar, according to a banker. Over the last few months, India and some other Asian countries have witnessed large portfolio investment inflows. India also raised the investment limit for overseas investors in government and corporate bonds and there is the potential of overseas money standing by to invest in initial share sales of Indian companies. All these factors combine to make a case for a stronger rupee, according to a banker.

Still, some economists are critical of RBI for opening doors for greater inflow of overseas money in bonds at a time when it should be taking measures to prevent the rupee from appreciating. India could also consider some steps to slow inflow of overseas funds .

“There hasn’t been much of an impact on exports so far and the rupee should begin to stabilise around the current levels now,’’ said Vasant Mehta, who was the president of the Gems and Jewellery Export Promotion Council until last week. “Our exports have grown in China, the Commonwealth of Independent States and Middle Eastern markets, making up for the loss in western markets.’’

“Exports are not getting affected since the dollar has been weakening and putting all competing countries in a similar situation,’’ said Ajay Sahai, the director general and chief executive officer of New Delhi-based Federation of Indian Exporters Organisation. “We are telling exporters to cover their risks and be prepared for the rupee to gain up to 42 by December.’’