Overvalued Re Faces Sea Change, Say Analysts

The rupee could face a sea change following a sudden drop in the formerly solid currency this week, analysts said on Thursday.

Our view is that the rupee has to depreciate by around 5-6 per cent by the end of 1997/98 (April-March fiscal year), said Rajan Govil, economist at securities firm HSBC B&K.

We expect the rupee to depreciate to around 37.80 per dollar by end-March 1998, Govil said.

He said market sentiment seemed to have changed and the rupee was unlikely to return to levels seen over the past year.

The rupee weakened on Wednesday to an 18-month low of 36.14 per dollar on a newspaper report of plans for a change in exchange rate management, via introduction of a dollar-rupee trading band.

The central Reserve Bank of India (RBI) called the report misleading and the rupee recouped some of its losses, but analysts said market sentiment seems to have changed.

In afternoon trade Thursday, the dollar was quoted 36.08/10 rupees. Before Wednesdays fall, the Indian currency was stuck in a 35.70-35.85 per dollar band for more than a year. Dealers said the newspaper report had achieved what the central bank had failed to do over the past year.

One newspaper report achieved what the RBI couldnt do in one year, said the chief dealer at a state-run bank, referring to persistent dollar purchases by the RBI over the past year to counter the local currencys strength.

In the four months beginning April 1, the central bank bought $4.6 billion, with little impact on the exchange rate.

Analysts said the RBI had to refrain from more aggressive intervention as it had to weigh the effects of its dollar buying on domestic money supply.

Dollar purchases inject rupees into the banking system, boosting money supply and fuelling inflationary pressures.

Latest RBI data shows year-on-year money supply (M3) growth at 16.7 per cent for the fortnight ended July 18 against the target of 15.0-15.5 set for 1997/98 (April-March). Market sentiment now seems to be that the rupee will weaken, Govil said. This should lead to increased demand from corporates holding open positions, and dollar supplies slowing down till the market stabilises.

He said the rupee was likely to remain down as he expects imports to pick up in the second half of the financial year.

If oil companies are reimbursed their dues by the government, they will buy dollars from the market, Govil said.

At the moment they are borrowing abroad. Their dollar demand should also keep the rupee at a more realistic level.

The government owes oil companies around Rs 19000 crore for selling petroleum products below market prices to support Indias subsidy regime.

Analysts said a weakening in the rupee was required to maintain export competitiveness.

The rupee has appreciated in real terms while other regional currencies have depreciated, said Aashish Pitale, debt analyst at ICICI Securities and Finance Co.

So our relative competitiveness vis-a-vis our immediate rivals in the world markets has gone down, Pitale said.

He said an overvalued currency increases the chances of a speculative attack once the rupee becomes fully convertible on the capital account.

An expert committee has recommended full convertibility by the year 2000, subject to certain conditions being fulfilled, including a reduction in fiscal deficit and inflation and an improvement in the financial health of banks.