Rupee may weaken on widening CAD

The widening current account deficit (CAD) poses a major concern for the movement of the rupee against the dollar. Today, the Reserve Bank of India (RBI) raised concerns on CAD and the Street believes the rupee is at major risk due to this.

“Domestically, the widening of the CAD to historic high levels, in the context of a large fiscal deficit and slowing growth, exposes the economy to risks from twin deficits. Financing the CAD with increasingly risky and volatile flows increases the economy’s vulnerability to sudden shifts in risk appetite and liquidity preference, potentially threatening macroeconomic and exchange rate stability. Large fiscal deficits will accentuate the CAD risk, further crowd out private investment and stunt growth impulses,” said the RBI in its third-quarter monetary policy review statement today.

The Street thinks the rupee, which ended at 53.78 a dollar today compared with the previous close of 53.92, may again weaken to 55-56 a dollar in 2013. “The rupee is at major risk from a widening CAD, heavy dependence on foreign institutional investors (FIIs) flow and bunched dollar demand. These factors do not rule out sharp weakness in the rupee into 55-56 a dollar during 2013,” said J Moses Harding, head of economic and market research, IndusInd Bank.

The CAD has widened primarily due to worsening of the trade deficit. “Portfolio inflows to Indian markets totalled $14 billion between September and December 2012, up 11.2 per cent year-on-year, but this fell significantly short of the $76.5 billion trade deficit over the same period,” points out a report released by Standard Chartered Bank today.

“While the government has stepped up its efforts to curb the trade deficit, primarily by increasing import duties, the impact of these measures is unlikely to be felt immediately. Thus, the fundamental backdrop remains mixed for the rupee,” said Anubhuti Sahay, Nagaraj Kulkarni and Priyanka Kishore of Standard Chartered Bank in the report.