beyondbrics

The rupee hit a 30-month low against the US dollar at Rs50.18 Friday morning, just four days before the Reserve Bank of India is likely to raise interest rates for the 13th time since March 2010 as it fights to contain persistently high inflation.

The rupee should continue heading south in the near-term and could even go as low as Rs52 – near its record low of 52.18 in March 2009 – despite the central bank’s aggressive moves to contain inflation.

The eurozone crisis driving demand for US dollars, a rising trade deficit, market volatility and a drop in foreign inflows continue to hamper the rupee, analysts told beyondbrics. India’s currency has now depreciated 11 per cent against the dollar this year, the worst of all its Asian peers.

Amid such pervasive problems, V Balakrishnan, chief financial officer of India’s second-largest software exporter, told Bloomberg that India should follow China’s example.

“Rupee’s depreciation at such extreme levels is not desirable when the Indian economy is going through slower growth due to high inflation,” he said. “India should learn to manage its currency like China.”

Food inflation hit 10.6 per cent for the week ending October 8, the Ministry of Commerce & Industry reported yesterday – up from 9.32 per cent the week before – lending further credence to the widely-held expectation that the RBI will raise rates by 25 basis points to 8.50 per cent on Tuesday.

But analysts told beyondbrics that the markets had already priced in the hike – the major factor they are looking out for now is the RBI’s comments accompanying the increase.

“It will depend on the comments that the RBI governor makes: if there is a statement that says more or less that the interest rate hike scenario has stabilised then we might see gains in the equity markets and that could support the rupee – it could then appreciate,” Rajini Panicker, forex analyst at MF Global, told beyondbrics.

“If the statements continue to remain hawkish – and that is the trend we’ve seen from RBI – that would continue to be bearish for the equity markets, and the rupee will then depreciate.”

India’s trade deficit continues to climb, despite the weakening currency. The deficit for April-July 2011 was around $42.7bn, up 12 per cent from $37.5bn for the same period last year, according to the Ministry of Commerce and Industry.

Meanwhile, global investments into India were at a net outflow of $84.3m from the beginning of the year until Thursday, down from $23.8bn in inflows during the same period last year, according to the Securities and Exchange Board of India, further hurting the rupee.

In light of the lack of help from the government on fiscal policy, the RBI is forced to wield monetary policy as the country’s only weapon against inflation. Ramesh Kumar, from Asit C Mehta Investor Intermediaries, said he wouldn’t be surprised if the RBI didn’t go further than the expected 25 basis points hike.

“They may also increase [the cash reserve ratio], because they are really concerned about inflation and …they have made it very clear they are not getting any help [from the fiscal side], so it has to be harsh measures – that’s what the market is expecting,” Kumar told beyondbrics.

Even with such intervention, Sandeep Singal, co-head of institutional equities at Emkay Global Financial Services, said that no-one should expect the rupee to appreciate significantly for at least the next six months, and then only if monetary policy begins to loosen.

“I would directly correlate it to the high interest rate environment, so the moment we see the interest rate cycle reversing or flattening then we would see [the currency begin to appreciate],” Singal said. But that isn’t likely to happen for at least 6 months.

“My sense is that it can go to a [Rs52 per dollar] kind of level – the kind of rate of change that we have been seeing since the beginning of August… the speed of movement is very, very strong,” he said. “So the order of the day seems to remain high velocity.”

Related reading:
Rupee: this may not yet be the bottom, beyondbrics
The great rate divide: hikes in frontier markets match emerging markets cuts, beyondbrics
Special Report: India and Globalisation 2011, FT
India’s abject return to talk of Hindu growth rates, FT