rediff.com: Pressure on Re to remain, says JP Morgan

The Indian rupee will continue to remain under pressure from higher imports and likely rises in US interest rates, Dominic Price, head of J P Morgan India, said on Wednesday.

The rupee was quoted at new intra-day lows of 45.32/38 per dollar on Wednesday with the market unsure if import demand will persist and the central bank will intervene.

Price said the central bank had two options. It could meet the increased dollar demand or hike interest rates further during the year.

"The surge in economic activity has led to strong import growth, both oil and non-oil. This together with portfolio outflows of around half a billion dollars in the past couple of months has clearly tipped the scales against the rupee," Price said.

"There are worries. US interest rates haven't seen their highs and as a consequence, unless the Reserve Bank of India can take effective measures to stem the current demand for dollars or counterbalance that demand, the rupee will continue its slide in all probabilities," he said.

The RBI Governor Bimal Jalan on Tuesday said he was not worried about the rupee's fall.

The RBI hiked rates and tightened liquidity on July 21 when the rupee slipped below 45 for the first time, but the rupee's recovery was brief and it has continued its slide against the dollar.

Price said monetary measures were effective in stemming demand for dollars in the past, in January and August 1998, because then the dollar demand was believed to be speculative.

"The current demand is genuine importer demand, so rate hikes unaccompanied by tighter short term liquidity will not reverse those genuine flows," Price said. "History has proved time and again that you cannot control exchange rates and interest rates simultaneously. It's akin to holding the lid down on top of the pot without turning off the heat. Inevitably, somebody gets burned."

Of the options open to the central bank to keep the pressure off the rupee, the most important were augmenting dollar supplies or hiking interest rates again, the latter a less preferred option, Price said.

The country's foreign exchange reserves are down $2 billion in the past three months, and analysts said a large part was spent defending the rupee.

"If no effective measures are taken to augment those dollar supplies to meet that importer demand, then it seems to us...it is more or less inevitable that further rate hikes will be likely in the latter part of this year."

Price said the current bearishness in bonds, where yields have risen sharply tracking the rupee's fall, was because the market was not yet fully opened up. "It (the bond market) has a tendency to over-react and that is largely due to the fact that the level of liberalisation doesn't yet allow for shorting of bonds. So there tend to be no mitigating forces when the market tends to move one way or the other."

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