Rupee to be at REER till all-is-well

Most cues have turned in favour of the Rupee; most important are the sharp reversal in Brent Crude and Gold reducing the pressure on the CAD, robust FII/FDI/ECB flows through capital account, both combined keeping the Balance of Payment in favour to keep the market in dollar supply-driven mode. The risk from FED hawkish stance and its preparedness for shift into rate-hike cycle in 2015 and resultant worry of FII pull-out or dilution in off-shore inflows is significantly diluted by contra-stance of ECB with extended ultra-dovish monetary policy stance. All taken, there is no major risk of emergence of external headwinds against Rupee.

Domestic cues are very positive with expectation of significant improvement in macroeconomic fundamentals, diluting growth-inflation conflict. The worry on fiscal deficit is behind with pass-through of subsidies and revenue pick-up from disinvestment. While GDP growth momentum is seen to be in place, inflation-push factors from twin-deficit stay diluted. Supply-side concerns are not very relevant on capacity expansion bridging demand-supply gap and adequate monsoon. All taken, domestic cues stay supportive to Rupee.

Is the Rupee good for long term? There are serious structural issues that can pull the trigger against Rupee on any minor shock - domestic or external. There is need to keep Rupee exchange rate attractive till CAD woes are completely resolved. Till then, Rupee should be supportive to exports, restrictive to consumption of non-essential imports and attractive to off-shore inflows. The dollar reserves with RBI constitute hot-money FII flows with the need to ring-fence through strong dollar and elevated interest rate. The best option to manage domestic & external supportive cues against the structural imbalance is to administer Rupee exchange rate above REER which is moving above 60 tracking the dollar strength against major and emerging market currencies. The ideal 1 year range for Rupee is at 60-63 which is seen as win-all for all stake holders till Indian economy gets into high growth-low inflation position and squeeze in import-export gap for being less dependent on hot-money, fair-weather FII flows. 1Y target for Rupee is seen at 62, close to estimated REER retaining long-term bullish momentum on the USD.

Moses Harding