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Rupee seen continuing to rise on the back of FPI inflows, dollar weakness

LiveMint logoLiveMint 03-08-2017 Alekh Archana

Mumbai: The Indian rupee, which hit a fresh two-year high on Thursday, is expected to strengthen further owing to continued foreign fund inflows and dollar weakness, but the pace of the rise is likely to be slower, dealers said.

In large part, the pace will be determined by the central bank’s intervention in the currency market, they said. The Reserve Bank of India (RBI) has maintained that it does not target a particular level for the rupee and its intervention in the currency market is only to curb excessive volatility.

On Thursday, the rupee closed at 63.69 a dollar, one paise higher than the previous close and its highest level since 22 July 2015.

“Apart from the (foreign portfolio investment) FPI inflows and dollar weakness, exporters are selling dollars on a large scale, especially after the 64 level was tested on Wednesday. So my guess is that rupee will remain steady with a positive bias at least for the next three to four months,” said Harihar Krishnamoorthy, treasurer at FirstRand Bank.

The rise in the rupee has been due to surging inflows from foreign portfolio investors (FPIs) into the local equity and debt markets on the back of a positive view on the Indian economy. In addition, the recent fall in the dollar index to a multi-month low has also led to a rise in the rupee in line with its Asian peers. Recently, the dollar weakened against most global currencies because of uncertainty related to interest rate hikes in the US and President Donald Trump’s administration.

So far this year, the Indian currency has gained 6.64% against the dollar, while Asian currencies, barring the Hong Kong dollar and Philippine peso, have gained in the range of 1.1-7.7%.

Graphic: Ahmed Raza Khan/Mint

So far this year, FPIs bought $8.84 billion and $17.87 billion in the equity and debt markets, respectively.

On Thursday, the dollar index, which measures the US currency’s strength against major currencies, had fallen to 92.91.

Now, with FPIs having nearly exhausted investment limits in the local debt market, inflows into equity and a weaker dollar globally are being seen as factors supporting the rupee. The rise in the rupee is also expected to be slow because it is overvalued as seen by the real effective exchange rate (REER), a measure of a currency’s valuation.

The rupee’s REER was 118.10 in June, against a basket of 36 currencies. That means the currency was 18% overvalued, according to the trade-based REER.

However, RBI’s role in sterilizing dollar inflows may decide the fate of the rupee. RBI has been heavily intervening in the market since June in order to arrest sharp appreciation of the rupee, a fact derived from the rising foreign exchange reserves which have swelled to a record $391 billion.

The intervention by the central bank in the spot currency market is limited because of surplus liquidity conditions; RBI had to absorb a net Rs3 trillion on an average daily in July under its liquidity adjustment facility.

Thus, when the RBI purchases dollars in the market, it infuses fresh rupees, thereby adding to surplus liquidity. In order to avoid this, RBI has been also entering into forward contracts to negate such impacts. However, this route has limitations and hence the central bank may not find it desirable to continue to do so, dealers said.

At times when the Asian currencies are appreciating, RBI may not aggressively intervene to arrest rise in the rupee, according to Sajal Gupta, head of forex and rates at Edelweiss Securities. In the absence of such interventions, he expects the rupee to potentially rise to 62.80 a dollar in the next three months.

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