Rupee may weaken to 68-69 levels by December 2017. Here's why

The recent rupee move is partly frothy and may fade: Edelweiss

When most currency experts are giving a call that Indian rupee could be fairly valued, but with a slight strengthening bias, brokerage firm Edelweiss expect rupee to weaken to 68-69 a dollar level by December on global political risk and strengthening of the US dollar.

December is still some nine months to come and indeed the factors mentioned could materialise, pulling down rupee beyond its record low of 68.85 a dollar that it reached on 28 August, 2013. The rupee, for now, seems to be bullish. The recent move by the rupee was so strong that it triggered margin calls on many trading books and the Reserve Bank of India (RBI) had to heavily intervene to iron out volatility.

The rupee had moved from 66.61 a dollar to 65.82 a dollar on 14 March, a movement of 1.19 per cent, reacting to huge win of the Bharatiya Janata Party in the Uttar Pradesh elections. At 10.40 am, the rupee was trading at 65.11 a dollar.

“The rally in rupee reached higher levels post prudent budget, muted impact of demonetisation on GDP estimates and historic mandate in Uttar Pradesh to BJP further strengthened the rupee, making it more expensive than other peer currencies. We believe that the recent move in INR is partly frothy and may fade,” Edelweiss said, adding the narrowing inflation differential will be reversed as favourable base effects for India wade off.

“Though India’s macro remains stable, its suppressed inflation and differentials could widen causing INR to depreciate from current levels. We believe that INR may not be over-valued but it appears to be over-heated,” wrote Sahil Kapoor, chief market strategist and Shobana Krishnan, an economist of Edelweiss.

According to the report, real effective exchange rate (REER) of rupee shows it is quite expensive against the basket of currencies it is measured. REER is measured as the relative strength of rupee against its trade partner. Indeed, between March 2016 and February 2017, the REER of rupee has been on an incline.

REER value

However, the same report shows that the rise in REER in one month, between January and February, has been “too modest” in comparison with other emerging markets, mainly because of weakness in the dollar. REER for rupee has risen only 0.8 per cent against the dollar, compared with Mexico’s 5.1 per cent. However, rupee’s Asian peers have seen their REER falling against the dollar. Thailand has fallen 0.2 per cent, Indonesia has fallen 0.8 per cent and China’s REER against the dollar has fallen 0.9 per cent. This may indicate that rupee has a scope to fall.

Dollar index, which measures the greenback’s strength against major global currencies, have fallen to 99.294 against 102 in the start of March.

“Dollar had rallied in expectation of fiscal stimulus in US$. In absence of any big announcement, dollar weakened,” the Edelweiss report said.

Rupee weakness could be warranted for pushing India’s export growth. Even as nowadays the quality of the exports have improved, considering it is now driven more by value and less by price changes, a weak rupee can further push the exports. And the central bank is well aware of that.

For now, the Reserve Bank has limited scope to intervene in the currency market, considering huge liquidity surplus after demonetization. But once this liquidity slowly neutralises, the central bank can intervene more actively to weaken the rupee, according to Edelweiss.

Some currency consultants have given a call that rupee would appreciate to 62-63 level by June-July and can strengthen further as the months pass, but clearly, Edelweiss doesn’t buy that.