Friday, April 6, 2012


INR remains one of the riskiest currencies. India’s large and widening current account (CA) deficit and its dependence on volatile capital inflows make it vulnerable to becoming a casualty of swings in global risk appetite and crude oil prices. INR’s recovery in January was due partly to RBI’s aggressive currency intervention, although global risk-on, RBI’s antispeculative measures and deregulation of NRI deposit rates also helped. However, INR has been weakening against USD since early February, despite a surge in portfolio inflows into India (1Q12: around USD13.5bn). Global risk-on will likely boost volatile capital inflows unless domestic factors, such politics and policy coordination, are turn-offs. But capital inflows may not be adequate to eliminate concerns about smooth financing of the CA deficit. On our forecast, the CA deficit of 3.9% of GDP in FY13 is beyond the RBI’s comfort level. This, along with our expectations of a stronger dollar, sets the stage for INR to weaken. We maintain our end-2012 forecast of INR55:USD.

INR has had an exceptionally volatile ride (Figure 1). It slumped to nearly INR54:USD in mid-December before recovering to INR49:USD by mid- February due to a combination of an unexpectedly strong jump in portfolio inflows triggered by global risk-on and RBI’s desperate measures, including aggressive currency intervention in January. However, it weakened subsequently and has broken above the 51-mark despite USD weakness. The pace of capital inflows has slowed recently even as the CA deficit remains large. In the absence of meaningful RBI currency defence, INR had to weaken. But no economy with a large CA deficit should rely mainly on portfolio inflows to finance the deficit as these inflows can be uncertain. Also, it is unlikely that capital inflows will comfortably and smoothly finance the wider CA deficit in FY13.

Second, outlook for USD. We expect USD to strengthen in 2H12, which in turn should be negative for INR. Note that INR has weakened in recent weeks despite USD weakness (Figure 4). Such an outcome does not boost confidence.

To read report in detail: INDIAN RUPEE