The Indian rupee has dropped more in this quarter than it has over any comparable period over twenty years, after the withdrawal of bond incentives from the US Federal reserve that stimulated investment in emerging-market assets.
The Fed comments have got the market re-pricing, and it’s anyone’s guess how long it will be before the rupee stabilizes again. The rupee fell 5.6 % in July alone – the worst performing of 78 currencies worldwide – amid concerns that the country’s Balance of Payments would worsen on the back of the fed’s bombshell.
Since then, Federal Bank President W.C. Dudley said that there was a possibility that the asset-purchase program might be prolonged, causing a slight but immediate improvement in the rupee.
On the whole though, the outlook is for further setbacks in 2013. Given the lack of foreign currency reserves, central bank intervention if any, is likely to be limited. Analysts seem to agree that large-scale intervention would be both impractical and unlikely, so the currency is in for interesting times as it strives to find its own balance.
Although it would be unwise to invest in the rupee as yet, it will certainly be an interesting currency to watch in the coming months. It seems likely that, as is often the case, it will plummet to a rate that will reflect a lower value than it is capable of, before rising again to stabilize around a more realistic median value.
When this will happen is anyone’s guess at this point, but careful monitoring of the market will allow for a better judgment-call closer to the time. There’s a lot of hope for a recovery, though. The IMF ‘slashed’ the forecast for Indian economic growth to 5.6%: still a level many markets would find enviable.
As a result, many investors are holding on to their Indian investments in the hope of the expected rebound, despite the Fed’s measures to withdraw their support and the subsequent souring of the market, with many investors selling off their Indian holdings in anticipation of further reverses for the rupee.
The Fed is on the fence with a ‘We won’t, but maybe we’ll still consider it’ stance. At present, their lack of complete commitment allows for a degree of optimism, but most people are feeling relatively pessimistic. Should the Fed make a firm commitment to extend the asset-purchase program, it’s likely that the effect on the rupee will be immediate, but only last as long as the extension.
However, the current crisis has brought home to policy-makers that economic dependence on dollar support is dangerous in the event of its withdrawal, and that no such policy will last forever.
In India’s favour are its relatively robust economic growth and its prominence in export markets, which will be enhanced by the rupee exchange rate. Although the economy and the currency will certainly be worse off without Federal Bank incentives, it still seems likely that the rupee will bottom out, then rise and normalize.