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Rupee fair value between 55-65/$: BofA-ML

Even as analysts fret over what is expected to be the first Federal Reserve interest rate hike tomorrow in the longest time, and try to foretell is impact on emerging markets currencies, one economist is not unduly worried and says it is the US dollar that may come under pressure when it comes through.

Given that backrop, Indranil Sengupta, India Chief Economist, Bank of America-Merrill Lynch, says the rupee could appreciate to 65 levels versus the dollar by March 2016.

“Inflows into India had dried up because of the Bihar elections, the impending Fed rate hike and a delay in earnings turnaround,” he told CNBC-TV18. “With Fed out of the way and earnings expected to turn around, as well as thanks to an increase in the FPI G-sec investment limit from January 1, the rupee can appreciate.”

Sengupta said he believes the US dollar is overvalued by 15-20 percent versus the euro, and that its fair value is somewhere around 120-130 versus the common currency.

For the rupee, he maintained its fair value was somewhere between 55-65 versus the greenback, adding that it would result in strength for the Indian currency. “The rupee has support of valuations,” he said.

What are the risks to Sengupta’s bold call? If the dollar witnesses a major appreciation next year on account of a tighter-than-expected Fed monetary policy.

“The market is pricing in two Fed hikes next year. [The dollar could appreciate if there are more],” he said.

Below is the verbatim transcript of Indranil Sengupta’s interview with Ekta Batra & Anuj Singhal on CNBC-TV18.

Ekta: We are already at the lowest level since September 2013 for the rupee so in our opinion do you think that the worst is already factored in and we have factored in the fed rate hike of the rupee or is there more weakness that we can see?

A: We do think that the worst is over and we were talking of three event risk one was Bihar, the other is the Fed and third is a turnaround in earnings. With the fed done and earnings turning around flows coming in from seasonal perspective, foreign portfolio investors (FPIs) government securities (G-sec) investment hike from January 1st we think that rupee can roll down to 65 per dollar by March. We think that in the fourth quarter the rupee will gain because of all these three factors.

Anuj: What is your biggest risk factor to your call on the currency?

A: The biggest risk factor is if there is a major appreciation of the dollar. I think the issue is that the market is largely pricing in two Fed hikes next year. The Fed dot plot suggests four to five. So, I think the important thing to see is does the Fed come in and look as if they have been dovish supportive of growth or do they look like hawkish.

So, that is one risk that we will come to know on Wednesday night. However, apart from that clearly seasonality is on the side of the rupee like I said investment hikes will happens for bonds and earnings should begin to turnaround from the December quarter.

Ekta: You said 65 by March 2016?

A: Yes.

Ekta: Do you think that we could touch our record lows or play with 68 per dollar before that?

A: On the momentum anything is possible. However, the fact of the matter is that maybe the dollar is now overvalued by anything between 15-20 percent. Put the fair value of the dollar anything between 120-130 a euro and similarly the rupee is undervalued. Not in terms of the real exchange rate (RER) but purely in terms of the dollar cross the rupee fair value is probably somewhere between 55-65 per dollar. So, while momentum takes you sometime to 68 per dollar sometimes it takes you to 55 per dollar. Somewhere I think the rupee now has a support of valuations.

Ekta: What is your sense in terms of flows? What could we see in terms of resumption of may be foreign institutional investor flows in equities something more sustainable in the debt market?

A: We think there are going to be three phases like I said that we were saying that flows would dry up in end 2015 because of these three factors. Again flows should resume now. May be end of the year again may be the last quarter of 2016 will be tough for flows because there is going to be change at the RBI or not. There at least USD 15 billion will at least flow out because of foreign currency non-resident (bank) (FCNR(B)) flows a deposit maturing.

There will be this entire foreign exchange (FX) repayments build up by banks and corporate and finally there will be the uncertainty because of the UP polls. So, just as you had a phase of event risk which dried up flows now you might get a phase, event risk which dry up flows towards end 2016. However, somewhere between January and February to August –September we do see flows resuming.

Anuj: What are you factoring in terms of RBI action for next calendar year in terms of further rate hikes or rate cuts rather?

A: We are looking at a final rate cut on February 2nd and then a long pause.

Ekta: Final rate cut and quantum – 25 bases?

A: 25 basis points.


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