Dubai: A rebound in the Indian rupee may be short-lived as a recipe for disaster is in the making, fund managers say.
A stronger dollar, high inflation, along with expectations of a rate cut after the new central bank governor assumes office in September, could be a combination that could spell disaster for the currency in the medium term, currency strategists say. UBS feels that the Indian rupee may hit a new record of 71 in the next 12 months. The Indian rupee has rebounded in the past six months on the back of a revival in investor confidence, after touching a near record low in February. The currency struck an all-time low of 68.8450 in 2013.
“We forecast the rupee to weaken to 69, 70, 71 versus the USD over 3, 6, 12 months respectively. This comes on the back of a broadly stronger US dollar, given our expectations for Fed to hike in December, which is only marginally priced in by the markets,” Teck Leng Tan, analyst at UBS Wealth Management told Gulf News in an email.
A rate cut by the Reserve Bank of India may fuel a rally in stock market in the short-term, but over a medium to long-term when the positive impact from the rate cut is over, there could be outflows and possibly depreciation in the currency.
Other factors that could adversely impact the currency is the UK’s decision to leave the European Union. UK’s departure from the European Union may adversely impact India’s growth through trade and financial channels, Morgan Stanley said in a note to clients, impacting flows.
“At this stage, the impact (of the new appointment) on the currency seems only marginally negative. Though the new governor appears to be less hawkish than his predecessor, he is nonetheless unlikely to undo the inflation targeting framework put in place. As such, we do not expect an overly loose monetary policy setting to lead to a drastic widening of India’s current account deficit,” Tan said.
Raghuram Rajan, the governor of Reserve Bank of India will leave the central bank when his term ends in early September, after a member of Prime Minister Narendra Modi’s ruling party publicly criticised him for keeping rates unnecessarily high.
However, there would be pull factors as well working in favour of the currency. The good and services tax (GST), which would create one of the world’s biggest single markets, is expected to keep a lid on weakness in the currency.
“The consolidation of multiple tax items, under the common GST bill, is a structurally positive reform for India. Coupled with our positive view of Indian equities, we expect these factors to keep the rupee relative stable (against a backdrop of a stronger US dollar), which makes it attractive to hold for its attractive yield,” said Tan from UBS.
An official at Barings Asset Management also agreed.
“India tax processes (after the GST) should be more straight forward and that should improve from the cumbersome tax policy mechanism of the past. We expect the future effects are positive in those fostering economic activities. That should also indirectly supportive to the domestic currency in general assuming other factors constant,” said Dr. Sean Chang, head of debt management at Barings Asset Management.
Brisk trading on DGCX’s rupee contracts
Indian rupee contracts witnessed brisk trading in July Dubai Gold and Commodities Exchange (DGCX) as it recorded the highest monthly average open interest of 144,184 contracts in July 2016.
Monthly Average Daily Volume (ADV) on the Indian Rupee Quanto contract registered a year on year growth of 351 per cent.
Indian Rupee options registered a Year-to-Date (YTD) increase of 150 per cent. ADV on Rupee futures grew by 27 per cent, trading 45,842 contracts in July 2016.
“Open Interest is an indication of the resident interest and liquidity, and also demonstrates the robustness of our trading platform,” Gaurang Desai, chief executive officer of DGCX said in a statement.