Outlook for INR/USD

The Indian Rupee (INR) has been extremely volatile in last two years. The currency has touched its peak and trough vis-à-vis the US dollar (USD) in these two years (see the graph below). During the same time, the INR defeated the forecasts made by most of the top notch global & Indian banks. I still remember when rupee was trading around 40 per dollar in Jan’08, few big agencies were betting on the INR going below 30 per dollar by end-2008. This was one extreme though. But most of the agencies were of the view that the INR will keep appreciating though out the year (2008). It didn’t happen. On the contrary, the INR depreciated around 20% to 50 per dollar in the same year. The other extreme was when these agencies were forecasting the INR to touch 57 per dollar merely four months back. So I assume you understood the plight of the forecasters.

What went wrong?

The rupee depends very heavily on Foreign Institutional Investor (FII) flows. If FIIs start sending money to Indian financial markets, the currency appreciates and if FIIs pull out money from India, rupee starts taking a hit.

Rupee dependence on FII flows

Forecasters were very bullish on India’s growth story in the beginning of 2008 and were anticipating heavy FII inflows. But FIIs actually pulled out $9.3 billion from Indian markets in 2008. Due to these heavy capital outflows the INR tumbled to around 50-levels against the USD in Dec' 08.

The way forward

The rupee appreciated very sharply around 47-levels against the dollar following the general election results on May 16. A surge in FII inflows fuelled the INR rally against the greenback. However, the rupee has lost over 2% in last fortnight and is trading at around 48-levels against the dollar.

Economic outlook for India has improved to some extent in last one month. The industrial production data, core sector data, manufacturing PMI, and GDP data are the ones which paint a positive outlook for India. The IIP expanded 1.4% (y/y) in Apr09, after remaining in the negative territory for two months. The core sector posted a growth of 4.3% (y/y) in the same month. Manufacturing PMI expanded for a second straight month in May09 to its highest in last eight months. Moreover, as I have mentioned in my previous post, the World Bank has upwardly revised its India’s GDP forecast for 2009 & 2010 on June 22. The next major event is the fiscal bill, which will be presented on July 6.

A better growth prospect will lead to higher capital inflows in the coming months. This builds up a case for a stronger rupee in the medium-term. Therefore, the rupee is expected to be around 46-levels against the dollar by Mar 2010. However, in the immediate term, the rupee could trade in a volatile range, tracking the developments in the equity markets and also the performance of the dollar vis-à-vis other currencies.