Goldman sees snorting rupee ease on trade, policy pressure

Current account deficit, India’s higher inflation compared to major trading partners can’t sustain expensive currency

The rupee which has appreciated by 8.7 per cent in the last nine weeks is likely to weaken from these levels gradually, says global investment bank Goldman Sachs. “The recent appreciation in the rupee has been unprecedented in its scale and timing. In our view, the recent run in the currency shows symptoms of over-shooting. Therefore, we are revising our 3-month, 6-month and 12-month dollar-rupee targets to 41.3, 42.1 and 42.4 respectively,” the US-based firm said. The rupee closed cheaper at 40.59 on Thursday.

The primary determinants of short-run movements in the rupee are the balance of payments and RBI intervention to curb volatility. Going forward, the inter-play of these forces suggest a weakening of the rupee.

“First, the current account deficit is set to widen due to the recent appreciation of the rupee. Second, we think that capital inflows are unlikely to show the growth that they did in FY’07. Third, the RBI is under pressure to weaken the rupee to restore competitiveness. Fourth, India has a positive inflation differential with partner countries, implying a depreciating rupee in PPP (purchasing power parity) terms,” it said.

Story continues below this ad

With inflation currently around 6 per cent and gradually slowing credit and money growth after the significant recent monetary tightening, the incentives to use the exchange rate to fight inflation have been reduced.

“The RBI is under pressure to intervene to weaken the rupee. Indeed, with the appreciation having been so large, the costs in terms of foregone growth in exports, output, and employment seem to outweigh any further benefits that upward flexibility would bring,” the firm said.

It is the small and medium enterprises, that generate most of the employment in sectors like textiles, food processing, leather, gems and jewellery, that will be hit the hardest.

“For a low-income economy struggling to generate jobs for its rapidly growing youth population, such a policy seems remiss. Additionally, India also has a positive inflation differential with partner countries, implying a depreciating rupee in PPP terms. Our estimates suggest that the rupee has moved significantly above its PPP level in recent weeks,” it added.

Story continues below this ad

According to Goldman Sachs, the risks to its views are: the capital inflows that are much stronger than expected, both due to carry trade as well as higher-than-expected FDI, leading to rupee appreciation and lower export growth. A second risk is that food price inflation continues to be high, if the monsoons are not normal. This would prompt the RBI to again refrain from intervening, in order to use the exchange rate to curb inflationary pressures,” it said.

Reading the rupee

• Current account deficit is set to widen due to the recent appreciation of the rupee.

•Capital inflows are unlikely to show the growth that they did in the last financial year.

• RBI is under pressure to weaken the rupee to restore competitiveness.

Story continues below this ad

• India has a positive inflation differential with partner countries, implying a depreciating rupee in purchasing power parity terms

• The US-based firm has revised its 3-month, 6-month and 12-month dollar-rupee targets to 41.3, 42.1 and 42.4 respectively