Demonetisation Be Damned! The Indian Rupee Is On A Tear

(THIS ARTICLE IS COURTESY OF QUARTZ INDIA)

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Demonetisation be damned! The Indian rupee is on a tear

March 17, 2017 Quartz India

It’s been a great week for the Indian rupee.

On March 16, at Rs65.41 per US dollar, the currency hit a one-year high against the greenback.

Much of the strengthening has to do with the ruling Bharatiya Janata Party’s (BJP) recent electoral wins in Uttar Pradesh and Uttarakhandand solid performances in two other states. The strong showing reflects just how well the party is positioned to sweep the next general elections in 2019 and hand Narendra Modi a second term as prime minister. Some of that magic is rubbing off on the markets.

“Since the start of the week, equity markets and the Indian rupee have rallied sharply in response to the strong performance of the main ruling party in recent state elections,” DBS Bank said in a March 16 report.

So far, the Indian currency has been the third-best performing in Asia in 2017. The rupee has gained 3.4% this year against the US dollar, only trailing the South Korean won and the Taiwanese Dollar.

Meanwhile, the US Federal Reserve’s interest rate hike on March 15—only the third since the economic crisis of 2008—hit the dollar. When the US dollar falls, capital outflows from emerging markets are restricted, thus strengthening local currencies like the Indian rupee.

The rupee’s strengthening comes after a free fall triggered by Modi’s move to demonetise 86% of the currency notes (by value) in November 2016. Initially it had been estimated that the currency ban would dent the GDP and take a toll on the economy.

In January, a Reuters poll of some 30 foreign exchange strategists had estimated that the Indian currency could see a record fall this year because of the currency ban. But India’s Central Statistical Office’s estimates show that the economy grew at 7% during the October-December 2016 quarter, and the rupee is holding strong.

One reason for the rupee’s surge is also that the macro-economic factors that influence a currency—inflation and current account deficit (CAD)—are looking good for India at the moment. While inflation is being restricted in its safe zone of sub 6%, India’s CAD (the excess of imports over exports) has also been falling.

What next

A strong rupee is good news for corporate India. Many firms hold debt in foreign currencies, so a fall in the exchange rate means their interest outgo will reduce. “Many Indian entities including short-term trade finance people remain unhedged for their offshore liability. They (companies) are likely to have gained from the rupee’s sharp rise in the last few days. At least, interest liability has reduced, adding to balance sheet gains,” Jayesh Mehta, country treasurer at Bank of America told the Economic Times.

However, the Reserve Bank of India (RBI) could soon step in to stabilise the rupee’s movement. Some reports suggest that the central bank already is buying dollars through public sector banks.

“The rupee appreciation, we feel is not sustainable and would revert to the range of Rs66-66.5 range, to begin with as the fundamentals do not warrant such unbridled enthusiasm,” a report by CARE Ratings said. “The outcome of the elections has been the main driving force. A strong rupee may not be good for our exports and the RBI is cognizant of the same.”