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Overvalued Rupee May Expose India’s Vulnerabilities: Standard Chartered Bank

Rupee is overvalued against a basket of major currencies: Ananth Narayan of StanChart 



Indian rupee and U.S. dollar banknotes (Photographer: Dhiraj Singh/Bloomberg)
Indian rupee and U.S. dollar banknotes (Photographer: Dhiraj Singh/Bloomberg)

The rupee’s longest strengthening streak in nearly five-and-a-half years could expose India’s vulnerability to a $50-billion trade deficit with China and unhedged currency exposure, said Ananth Narayan, head of financial markets at Standard Chartered Bank.

The rupee is back below the 67 level this week, first time in three months. The local currency has been strengthening since the dollar’s worst start to a year in more than a decade after Donald Trump, then U.S. President-elect, said the greenback is “too strong”.

The rupee is overvalued against a basket of major currencies, which doesn’t bode well for the economy, said Narayan.

“We can argue about the degree of overvaluation, but looking at our $50-billion annual trade deficit with China alone, a relatively strong rupee is not good for the Indian economy, and can lead to vulnerabilities,” Narayan told BloombergQuint in an emailed interview.

The unhedged foreign currency exposures that have built up since 2014 could also prove to be a worry, he said. “A relatively strong rupee, built on the back of unhedged currency exposures, is not good news for Indian manufacturing and employment. This also makes the currency vulnerable to external shocks,” Narayan said.

“Given the delicate state of the world—from populism and trade barriers to vulnerabilities in China’s banking system and Europe’s institutions—there are any number of risks that can trigger volatility in forex markets globally,” he said.

On the positive side, he said a stronger rupee could help bring back foreign money flows. “With yesterday’s (February 8) policy, where the RBI changed the monetary stance from accommodative to neutral, rupee-dollar differentials have widened again. This could help attract foreign investments. It might also make hedging imports and foreign currency borrowings more expensive,” he said.

Narayan expects the dollar to start strengthening and a gradual depreciation in the rupee to 69 over the course of the year.

FPI Interest In Bonds May Revive

Indian bond markets have seen a sell-off after the RBI’s unexpected change in policy stance.

The market feels there is a much lower probability of further rate cuts in this cycle. And at 6.25 percent overnight repo rate, the bond yields should rise, said Narayan, adding that the 10-year yields should settle in the 6.75 percent to 7 percent range.

“This week is the last government bond auction for this fiscal year. FPI interest in government investment should revive now with higher yields, and bank credit offtake remains at all-time lows. All this should help settle bond market yields,” he said.