Q&A: Mitul Kotecha, Credit Agricole Corporate & Investment Bank

'RBI may intervene to prevent too much volatility'

The rupee slipped to a near two-year low against the dollar, as the euro zone crisis worsened, weakening the euro and emerging market currencies. Mitul Kotecha, managing director and head (global exchange research), Crédit Agricole Corporate & Investment Bank, in an interview with Malvika Joshi, says the rupee stares at the risk of touching the psychologically important level of 50. Edited excerpts:

The rupee has been depreciating against the dollar sharply since the beginning of this month. What do you think are the reasons?
The rupee has been particularly susceptible to risk aversion. This partly reflects India’s reliance on capital flows. Recent data—like that on trade—have also not helped. As risk aversion has risen, the rupee has weakened and the currency is likely to remain under pressure, given the likelihood of risk aversion remaining elevated.

What is your short- and long-term outlook on the rupee?
The rupee is set to remain under pressure over the short term, since the global risk appetite continues to worsen. Worries about the euro zone periphery and the US economy suggest the risk appetite would not improve quickly. Consequently, if the pace of the weakness of the rupee continues, there is a risk that the rupee touching the psychologically important level of 50. Over the medium term, I believe the current weakness would prove transitory, and I expect the rupee to strengthen to around 45.40 against the US dollar by the end of this year and 42.90 by the end of the next year.

The floor has been set for the Swiss franc against the euro. How do you think this would change India Inc’s fund-raising pattern?
I think the floor for the euro/Swiss franc would deter many Indian and global investors from utilising the Swiss franc as a safe haven currency, as they shift from holding the euro.

What should the Reserve Bank of India (RBI) do to maintain a balance between exchange rate stability and its aim to make the capital account fully convertible?
If the drop in the rupee is extreme, RBI may be forced to take other measures to limit speculative trading in the currency and ensure stability. However, as long as such measures are seen as temporary, this should not interfere with the aim of capital account convertibility eventually.

Do you think RBI would intervene sometime soon to stop the rupee’s free fall?
As with other central banks in Asia, RBI may be inclined to intervene in the foreign exchange markets to prevent too much volatility in the rupee. If the currency's drop continues to accelerate, RBI is likely to intervene.

What strategy should be adopted by Indian export and import firms for currency hedging, given the current global economic uncertainty?
The rupee is likely to remain vulnerable in the short term, which could be costly for importers. Hedging against further weakness of the rupee may be necessary in the current environment. Assuming we are correct, the rupee should strengthen and this suggests such hedges should be undertaken to limit short-term foreign exchange risks. Conversely, exporters would benefit from the rupee's weakness. But they may seek to take the opportunity of short-term weakness of the rupee to hedge their long-term exposures.

Reports have surfaced that the yuan would be strong in the next few years and may act as a hedging currency. Do you think this is possible, given the large Chinese exports to the US and its large reserves of the dollar?
We expect the yuan to continue to strengthen over the coming months and years, while the Chinese authorities move towards greater internationalisation of the currency. The use of the yuan in international trade and hedging is still relatively small, but is expected to grow over the coming years, as China edges towards full capital account convertibility. Ultimately, China would reduce its reliance on the US dollar.