Fair value for dollar/rupee seen at 65.85-68.85 for rest of 2015

Post the rupee appreciation from 68.85 to 58.35 between August 2013 and May 2014, the value adjustment has been gradual to 63 by the end of 2014 and now at 66-66.50. The two-stage excessive move from 68.85 to 58.35 (up by 15 per cent in nine months) and 58.35 to 66.75 (down by 14 per cent in 15 months) did catch most stakeholders on the wrong foot, causing opportunity loss to exporters and real loss for importers and foreign currency carry-trade borrowers. The takeaway is: Rupee exchange rate fluctuations can cause serious damage to the balance sheet and bottom line if the risk-reward is not managed in a prudent way!

India's macroeconomic fundamentals have improved significantly since May 2014, not by domestic design but from favourable developments in the external sector, largely from a sharp drop in prices of crude oil and other commodities. The impact of the decline in the current account deficit (CAD) from five-seven per cent to one-two per cent of gross domestic product (GDP) is huge.

The current need is to prepare ground to sustain CAD at current levels against the risk of recovery in commodity prices, through significant export growth and reduction in consumption of non-essential imports. This can be achieved through administering rupee exchange rate competitive for exports and substitution of non-essential imports with cost-efficient domestic capacity build and expansion. India growth agenda needs significant off-shore long-term and stable investments, and to be less dependent on hot money from foreign institutional investors (FII) to fund the CAD.

The impact on the rupee is seen neutral from domestic cues and negative from external cues in the short term for FY16. While domestic growth concerns remain valid, comfort from the twin deficits (long-term stability in fiscal deficit at three-four per cent of GDP) and Consumer Price Index-based inflation (with downward bias at a four-six per cent long-term tolerance zone) will lead to a squeeze in interest rate differential between India and developed (and emerging) markets.

Support to the rupee exchange rate from an elevated FX premium might now turn resistive to appreciation. External headwinds from China and US are there to stay in the short term. China will continue to use monetary and exchange rate stimulus to support its export-intensive economy, while the US is expected to deliver a 50 bps rate hike during September-December.

The combination of a strong dollar (against major currencies) and a weak Chinese yuan (against emerging market currencies) will keep the rupee under pressure in the short term. If rupee value is not in alignment with value adjustment in EM currencies, India's export led "Make in India" growth agenda will be a distant dream.

What is the short-term outlook? All combined the appropriate fair value for dollar/rupee is seen at 65.85-68.85 for the rest of 2015 and at 70 by the end of FY16. It is a good time for the Reserve Bank of India to build its foreign currency reserves from current low level of $300-350 billion to over $500 billion, and to expand rupee liquidity for a gradual decline in domestic interest rates. There is nothing to panic, as long-term stability at 65-70 is a win-win for the Indian economy and its stakeholders.

The author is group chief executive officer- liability & treasury management, Srei Infrastructure Finance Ltd