Will the rupee rally last?

FIIs return to emerging markets as fears of Fed tapering ease, India's data improves; funding CAD could pose still be a challenge

The rupee no longer seems to be the ugly duckling among emerging markets currencies it would seem. After ending 2.1% higher at 63.84 on Tuesday, it rose another 0.74%% on Wednesday to 63.37 against the dollar. Currency strategists believe that the rupee will now remain capped at Rs 65.10 against the dollar as positive data from India and relatively weaker jobs data from the US will prevent any overshooting of the currency. This is in sharp contrast to the commentary emanating from currency strategists sitting in Hong Kong and Singapore. So what has changed fundamentally for the rupee? 

 

For one, the overtly bearish sentiment, which dragged the rupee down in August, has subsided as consensus is building around the notion that the Federal Reserve will not start tapering in right earnest from September. In just a week’s time, the currency market has now gone from being ultra long on the dollar to being bullish on the rupee, claim currency experts. 

 

No doubt, Raghuram Rajan’s maiden speech set the record straight, but the rupee's fortunes have changed for the better with fickle foreign institutional investors rediscovering emerging markets like India again. The not-so-promising data from the US has also helped. The rupee’s uptick has also drawn support from the US dollar, which has continues to trade flat with the dollar index (index against six major currencies) closing at 81.82 on Tuesday. A combination of domestic and international factors has driven the rupee up.

 

On Tuesday, foreign institutional investors (FIIs) bought equities worth Rs 2,564 crore. Since 4 September, FIIs have pumped in Rs 5,051 crore into equities. Kotak Securities believes that this is because the taper fear script appeared fatigued, as it had run way to long without a meaningful break. What has also helped is positive data emanating from China following the measures taken to pump up growth. However, the risk surrounding the funding the current account deficit are unlikely to be mitigated through such buying. 

 

Even though exports have been showing signs of recovering over the last few months, the rupee continued to fall in August as the market did not believe that the country would be able to fund its current account deficit. The fact that trade deficit for the month of August narrowed to $10.9 billion from 12.26 billion in July has also helped the rupee. Morgan Stanley expects the current account deficit to narrow to $12-13 billion for the quarter ended September 2013 (2.7% of GDP annualised) versus an estimated $21 billion in the June quarter (4.7% of GDP annualised). Economists say that the CAD coming close to 2.5% of GDP range is a good sign, for any sustained improvement inflation has to come down to make gold unattractive and oil prices have to stay benign.