Rupee gains despite swap window closure, other EM currencies continue to fall

Though forex reserves are up by $19 billion and the import cover has improved to 7.5 months, rupee continues to face taper risks

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Of all the fragile currencies, the Indian rupee has fared the best since September. After Raghuram Rajan took charge as the Reserve Bank of India (RBI) governor and rolled out currency stabilisation measures, the rupee has appreciated seven per cent.

Between September and now, the Brazilian real has declined 6.38 per cent, the Turkish lira by 4.29 per cent and the Indonesian rupiah by 5.74 per cent. Countries with ‘fragile’ high deficits have remained under pressure, as the fear of capital flows reversing remains strong. In contrast, the rupee has not only stabilised while the swap windows were open but has held on even after oil firms have returned to the spot market. It has appreciated by 2.26 per cent in December.

The daily demand for dollars from oil companies is close to $400-500 million. Though this demand has come back in December, there is no pressure on the currency. This is because  RBI recouped $34 billion through the concessional swap window offered to banks so that they could bring in foreign currency deposits. According to Shubhada Rao, chief economist at YES Bank, the swap windows would have helped increase reserves by $18-19 billion and improved import cover by a month to 7.5 months, compared to the 6.5 months seen in the second quarter of FY14.

From being one of the fragile economies, India has now moved to a position of relative strength, compared to peers. Economists are now expecting India to end FY14 with a current account deficit (CAD) of 2.5 per cent of GDP, against FY13’s 4.8 per cent. The dramatic improvement in the trade deficit is a big reason for the currency’s recent stability. November's trade deficit has fallen to $9.2 billion, compared to $17 billion seen last year. The fall in deficit was largely due to a 16.4 per cent fall in imports, driven by a 80 per cent fall in gold and silver imports.

So, what is likely if the US Federal Reserve’s bond buying taper does actually begin over the next few months? India cannot remain insulated from turmoil in the emerging markets. But the risks are now lower. After an outflow of $14 billion from Indian debt markets since May, the chances of a further sell-off are low. Also, improvement in India’s CAD should help anchor the currency. If curbs on gold imports are eased, the CAD could shoot up again. Bank of America Merrill Lynch expects the CAD to increase to 3.1 per cent of GDP in FY15 if gold imports are freed.

The currency may be stable as of now, but concerns remain. Historically, an import cover of 10 months is necessary for the currency’s stability and India is still not there yet. So, if a US taper were to start in December or January, the currency could again hit 68 against the dollar.