UBS pegs rupee at 55 on reforms boost by new govt

Rupee rise could lower inflation; at 55, therell be no diesel under-recoveries, so diesel subsidy will be nil

The rupee is expected to rally to the 55 level against the US dollar on expectation that the Narendra Modi government will push ahead with major reforms, Swiss brokerage UBS said.

"The unprecedented mandate for Narendra Modi and expectations around his reforms and development agenda implies the country's growth story hope will remain strong, at least in the next few months. It has also resulted in expectations of the rupee appreciation, with some investors are expecting it to go to 55 against the dollar," UBS Securities said in its report.

The rupee appreciation will most likely lead to lower inflation and less ambiguity. At 55, there will be no diesel under-recoveries and hence the diesel subsidy will be nil.

Fiscal deficit will be positively impacted by 20-30 bps, all else remaining unchanged. Fiscal revenue loss from 'lost growth' may be worth keeping in mind though, the report said.

Quoting an RBI research, it said a 10 per cent decline in the rupee can add to 0.4-1.7 percentage points to retail inflation in the long-run and 2.9 percentage points to headline inflation. The reverse may not be a mirror image but will be definitely moderate inflationary pressure, it said.

Over 30 per cent of WPI inflation can be classified as "imported inflation" such as that in fuel, fertilisers, metals and machinery, and this portion will be positively impacted directly by rupee appreciation.

However, if the associated enthusiasm manifesting in strong capital inflows given still likely muted current account deficit took the rupee to past highs on a real effective exchange rate basis (REER, on CPI basis) that would imply a rupee-dollar exchange rate of around 58 could be sustained through this calendar year.

A move beyond 58 may take the rupee into uncharted territory on REER basis. However, strong capital flows can create such a possibility anyway, in the interim.

Commenting on sectoral impacts of stronger rupee, the brokerage said, the rupee appreciation is a negative for IT service, but it is likely to be offset by demand positives.

Rupee appreciation is also a negative for pharma players. Given no delta in demand outlook for the sector as such, we remain underweight on the sector from a top-down perspective, UBS said.

Rupee appreciation can be a positive for some consumer companies on lower raw material cost, in the short term. But an inflation moderating environment in general is not good for demand and thus the sector in the near-term.