Widening Trade Deficit Likely To Hurt Rupee

A widening trade deficit is likely to weaken the rupee in the second half of 1997/98 (April-March), NatWest Securities said on Monday. "We see the rupee trading against the US dollar in the 35.8-36.0 per dollar range in the first quarter of FY1998, but weakening to 36.8 against the dollar by October/November 1997, and further to Rs 37.4 against the dollar by end March 1998," it said in a forex update.

"We have revised our export growth projection for FY1998 down to 8.0 per cent, although consensus expectation is still 15-20 per cent," the securities firm said. "Rising imports will increase the trade deficit and push the Indian rupee down," it said. The rupee was trading at 35.777/785 against the dollar on Monday.

 

The rupee appreciated nearly 0.5 per cent against the dollar in April. "At this point, it is overvalued in real effective exchange rate (REER) terms by nearly 5.5 per cent," it said. "The recent surge in foreign inflows led to expectations of further inflows, this has derailed the rupee completely and fuelled the current bullishness," NatWest Securities said. "However, the cyclical pattern of such expectations in the past leads us to the conclusion that the Indian rupee will weaken from the second quarter of FY1998 onwards." It said trade flows were a significant force in the Indian foreign exchange market, and account for more than half of the average market turnover. While the long-run direction of the Indian currency is benchmarked by purchasing power parity (PPP), the short-term movements have to be seen in the light of traders' expectations, it said.

"We observe that speculation by exporters and importers on the trade account further exacerbates the volatility of therupee," it added. NatWest said it expected inflows through the expatriate NRI deposits to moderate in FY1998. Inflows through foreign institutional investors (FII) and GDR investments are unpredictable, but there is no reason to be very optimistic about them given the current political uncertainty, it said. "Net inflows through external commercial borrowings will be higher in FY1998.

However, the trade deficit will also be significantly higher. Hence inflows in FY1998 will be far lower than in FY1997," NatWest said. As consumption demand improves, the trade deficit will widen and the forward rates will again firm to 5.0-6.0 per cent, it said.

Six month annualised forward premiums are currently below 4.5 per cent.