Swings in the rupee-dollar exchange rate may rise to a five-year high as the Reserve Bank of India [RBI] struggles to simultaneously combat currency gains and inflation, UBS AG said.
Efforts to strike a balance between curbing consumer prices and the exchange rate in the face of surging capital flows will see the currency fluctuate in a wider band, Bhanu Baweja, UBS's London-based strategist, said in an interview. A theory of economics known as the `unholy trinity' argues that it isn't possible to have free movement of capital, a fixed exchange rate and an independent monetary policy at the same time.
``The `unholy trinity' really means that the degree of freedom for the currency should rise,'' said Baweja. He recommends buying the rupee and 12-month call options on the currency. A call option gives the right to buy the rupee and puts grant the right to sell.
Volatility on 12-month rupee options may rise to 8 percent, the highest since November 2002, from 6.7 percent now, said Baweja. Traders quote implied volatility, a measure of expected price swings, as part of setting option prices.
The rupee traded at 40.385 against the dollar as of 11:22 a.m. in Mumbai. Baweja expects the currency to gain as high as 38 over the next 12 months, the strongest since November 1997.
Rising investment from overseas pushed the rupee to a nine- year high last month, forcing the central bank to step up dollar purchases and prevent the currency's advance from hurting exporters.
Net purchases of Indian stocks by global funds reached $10 billion this year through Aug. 6, surpassing $7.99 billion in 2006. Overseas borrowings by local companies increased six-fold to $16.1 billion in the year through March 31.
Foreign direct investment into India almost tripled to $15.7 billion in the year ended March 31 from the previous year, according to government estimates, and Trade Minister Kamal Nath aims to double it to $30 billion in this fiscal year.
The nation's currency reserves grew by $12 billion in the four weeks through July 27, twice as fast as in June, suggesting the central bank increased dollar purchases. Intervention increased money supply, stoking concern inflation will accelerate.
The central bank now needs to mop up the surplus cash from the banking system to keep inflation near a 13-month low of 4.03 percent reached in the week ended June 16. Governor Yaga Venugopal Reddy last week told banks to set aside more cash to cover deposits, and also scrapped the daily limit on the cash it drains through reverse-repurchase auctions.
``They need all the tools they can get,'' Baweja said. ``Demand remains pretty strong. We shouldn't forget foreign direct investment as a percentage of gross domestic product should be increasing at a faster pace as well.''
India is now looking to limit the influx of proceeds from external loans over $20 million to help stem the rupee's appreciation--not that the same tactic has worked for South Korea:
India's move to curb companies from bringing home overseas funds is probably one of the few weapons the government has to check record capital inflow without hurting investor confidence in the country, economists said.
The government yesterday imposed curbs on companies seeking to borrow from overseas to slow foreign-exchange inflows, about a week after South Korea imposed similar measures to cool the appreciation of the won.
India is trying to cool foreign-exchange inflows that sent the rupee to a nine-year high and weakened exports, which make up a third of the $854 billion economy. Finance minister Palaniappan Chidambaram today said the measures won't hurt investments and slow economic growth.
``Curbs on external commercial borrowings is probably the only step India could have taken,'' said Sebastien Barbe, the Hong Kong-based senior economist at Calyon, the investment banking unit of France's Credit Agricole SA. Barbe said the government may not curb foreign investments, which is supporting growth. He expects the rupee to decline to 42.50 by Dec. 31...
``India's liquidity problem will ease because investors will exit from their stock investments as the U.S. subprime mortgage crisis unfolds,'' said Arun Jain, director at V.S. Infrastructure Capital Ltd., which syndicates local debt for companies. ``Foreign banks will also be unwilling to fund Indian companies' mergers and amalgamations.'' [Indians bought MBSs?]
Indian companies made a record $55 billion of buyouts in the first six months of 2007, according to PricewaterhouseCoopers Pvt...
India yesterday said that companies borrowing more than $20 million overseas may not remit the proceeds to India, while the central bank's permission will be needed to repatriate funds up to $20 million. Net overseas borrowings by companies surged almost sixfold to $16.1 billion in the year ended March 31 from the previous year, according to the central bank.
Similar measures in South Korea had moderate impact on the won. The won slid 0.2 percent since Aug. 3 when the Bank of Korea restricted local companies from borrowing in foreign currencies to cool gains in the won and help exporters.
``India's restrictions will have a meaningful impact on the external commercial borrowing inflow,'' said Rajeev Malik, senior economist at JPMorganChase & Co. in Singapore. ``At best, they offer some breathing room to the central bank struggling to maintain a tight policy stance that is being challenged by the glut of capital flows.'' He said India should not restrict foreign investments.
India's central bank slowed dollar purchases in March and April to help strengthen the rupee and ease inflation from the two-year high it touched in January. Since June, it has stepped up dollar purchases, after inflation eased, to prevent the rupee from rising. In the process, it is injecting rupees faster than it can mop up, stoking concern inflation will quicken.
The nation's currency reserves grew $12 billion in the four weeks through July 27, twice as fast as in June, suggesting the central bank increased dollar purchases to contain the gain in the rupee. Inflation was at 4.36 percent in the third week of July, remaining below the central bank's 5 percent target for the past two months.
Reserve Bank of India Governor Yaga Venugopal Reddy on July 31 lifted the cash reserve ratio, or the proportion of cash that commercial banks must put aside against deposits, to 7 percent from 6.5 percent. The increase was the third this year, to soak up cash and keep a lid on inflation.
The government is concerned about the impact of a strong currency on exports, trade minister Kamal Nath said yesterday...
Merchandise exports grew 14 percent in June, the slowest pace in three months. Service providers such as Wipro Ltd., India's third-largest computer-services company, last quarter posted the slowest profit growth in more than two years after the rupee's appreciation eroded earnings. Its larger rival Infosys Technologies Ltd. last month cut profit and sales forecasts for the year.
``The government's step at an extraordinary time like this is helpful,'' said Kiran Karnik, president at National Association of Software and Service Companies. ``It should take care of some amount of pressure on the dollar. The appreciation of the rupee was too much and too fast.''
Still, global funds may add to the record $10 billion of Indian equities it has bought this year through Aug. 3, 25 percent more than in 2006, to take advantage of an economic expansion that is second only to China among the world's biggest economies. India's government expects the economy to grow more than 9 percent for the third year in a row in the fiscal to March 31.
``We continue to believe that the government and the central bank are fighting a losing battle against further exchange rate appreciation,'' said Robert Prior-Wandesforde, an economist at HSBC Holdings Plc in Singapore.