Rally partly due to weak dollar

The strong rupee raises questions. Firstly, what is driving this rally?

Mumbai: The rupee is one of the regional best-performers this year, rising about 6.8% since January this year against the US dollar, but not all of that is due to strong domestic factors.

Consequently, it might be difficult to sustain the rally in the Indian currency, which is partly fuelled by the weakness in the US greenback, DBS Bank said in a research note on Monday. “Both global and domestic factors have helped,” DBS Bank’s India Economist Radhika Rao said in the note.

“The strong rupee raises questions. Firstly, what is driving this rally?” Radhika Rao said, adding, “Besides a weakish dollar, both pull (domestic) and push (global) forces have supported the economy and the rupee.

While the economy’s structural story continues to improve at home, the global environment has been conducive at the same time, the note added. “Unlike the past, the US dollar and rates are still low even as policy tightening gets underway,” it said.

Earlier last week, FE Online had written that a weaker US dollar seems to have played a significant role in the rupee rally. “It is… an uphill task to defend a weak dollar-driven strength in the rupee,” DBS Bank said in its Monday’s note.

Further, in the emerging markets, the wide real rates have been a draw for the investors, DBS Bank noted, adding, “A flows-driven rally in the currency also runs the risk of reversal should risk sentiment weaken unexpectedly.”

However, in the short-term, rupee appreciation may continue on the back of a weak US dollar and domestic positives, the note said. It also said that unlike in the past, while a strong currency is a threat to India’s export earnings, there are other factors that can mitigate the impact on exports.

“A strong currency poses headwinds to exports/ manufacturing growth. Past trends suggest the impact on exports shows with a lag of three-four quarters,” the note said.

However, at the same time, imports-intensive industries fare better due to cheaper inputs, it said, adding, “Broadly, the import content of India’s exports rose to 25% of gross exports in 2010-11 from sub-10% in 1990s, implying that a decent proportion will stand to benefit.”