How soon will rupee crack 45/$?

From over Rs50 per dollar in late March, the Indian currency is now trading at around Rs46, a mark-up of nearly 9% and the question is, not if, but how soon, it will breach the Rs 45 barrier.

If in the last fiscal, it was despondency all the way, there is a distinct reversal in the fortunes of the rupee thus far in 2009-10. Surging capital inflows, bullish fervour in the stock markets, arbitrage opportunities and an economy on the mend, all these have propelled the rupee upwards against the greenback.

On October 16, it traded at Rs 46.26 per dollar as against Rs50.57 on March 26, 2009 and Rs 48.84 a year ago. Analysts believe it may strengthen to Rs 45 by December, if not earlier.

The Reserve Bank of India (RBI) is content to be a passive observer since the gyrations in the forex market seem to be more orderly. Two factors may be at play here. One, it is the fundamentals that have underpinned the rupee: while exporters, including information technology companies, may be hit, the rupee cost of imports is becoming cheaper. Since in the context of the drought, scale of food and edible oil imports may be higher and crude imports may also tend to go up, a strong rupee acts as an antidote to inflation. Two, foreign funds are pouring in, making supply of the dollar abundant in relation to demand. Global cues also suggest that the dollar is weakening against many currencies and the rupee is no exception to this trend.

The RBI has repeatedly averred that it has no specific target rate to go by, but it is only interested in minimising the volatility in the market. Barring any dramatic change in the present environment, the rupee will move only in one direction — up.

The principal factor behind the appreciating rupee is the massive inflow of overseas capital. This is reflected in the incremental surge of over $23 billion in our foreign currency assets thus far, as compared to the March 2009 level. Till August, according to RBI, foreign direct investment has topped $16 billion and portfolio investment has exceeded $ 11 billion. NRI deposits have swollen to $2.4 billion.

In view of the positive outlook for the economy, this trend is expected to continue and gather steam in the weeks ahead. The cheerful conditions in share markets are likely to prove a magnet for larger portfolio funds from abroad; in turn, increased foreign institutional investment in the market may fuel a further rise in stock prices so that a mutually reinforcing trend may be in evidence.

However, a rising rupee could hit exports. The rupee earnings from exports may suffer a setback. More serious will be the plight of software companies. This sector is showing nascent signs of recovery and the upward movement of the rupee against the dollar may be the proverbial spoilsport. But, with import costs lower, and India slated to import crude, edible oils and capital goods, imported inflation may be less onerous than would be the case if the rupee were on a downslide. The resultant large trade gap could be met from invisible receipts, dominated by remittances from the Indian diaspora.