India Will Support Rupee, Standard Chartered Predicts

By Anoop Agrawal

July 24 (Bloomberg) -- India's central bank will support the rupee and increase interest rates twice more this year to combat inflation, according to Standard Chartered Plc.

Asset managers should turn ``neutral'' on the rupee from ``underweight'' as authorities ``have finally woken up'' to the inflation threat and are starting to raise rates to ``more appropriate levels,'' the U.K. bank that makes most of its money in Asia said in a research report dated yesterday. Policy makers appear to be defending the rupee from weakening past 43.50 as a decline may exacerbate inflation, according to the bank.

``We believe risk-reward balance has changed for the rupee as tight monetary policy could mitigate rupee weakness for now,'' Thomas Harr, the bank's Singapore-based strategist, said in an interview yesterday, confirming the contents of the report he co-authored. ``Most negatives for the rupee are currently in the price.''

The rupee gained 0.3 percent to 41.95 per dollar as of 12:24 p.m. in Mumbai, according to data compiled by Bloomberg.

The currency yesterday rallied 1.5 percent, the most since January 1998, on speculation the government will allow more overseas investment in the financial industry after Prime Minister Manmohan Singh survived a confidence vote on July 22.

Crude Oil

The rupee closed at 42.08 yesterday, the highest level since May 12, according to data compiled by Bloomberg. The local currency has rebounded 3.7 percent from a 15-month low of 43.475 it touched on July 1 as crude oil prices slumped almost 16 percent from their July 11 record to trade below $125 a barrel.

The Reserve Bank of India may increase its benchmark repurchase rate, or its overnight lending rate, twice by 50 basis points each to 9.5 percent in 2008, the analysts said. It may also raise the reverse-repurchase rate, or the rate at which it drains money from the banking system overnight, twice by a similar amount to 7 percent.

India's inflation rate has tripled this year as crude oil advanced 69 percent in the past 12 months. Wholesale prices climbed 12.03 percent in the week ended July 12, the fastest since February 1995, economists said before a government report today at 5 p.m. in New Delhi.

Policy Rate

Reserve Bank Governor Yaga Venugopal Reddy increased the policy rate twice in June after keeping it unchanged for almost 15 months. He last raised it on June 24 by the most since 2000 to 8.5 percent.

The currency may end the third quarter at 42.80 against the dollar and 43 by end-December, Standard Chartered said, lifting its earlier forecasts of 43.25 and 43.50 respectively.

The U.K. bank said the widening shortfall in the nation's current account is a risk to the rupee's forecast as capital inflows into Asia's third-largest economy dwindle.

``India still runs a large current-account deficit making it dependent on capital flows,'' Harr said. ``We expect the deficit to widen. In an environment of rising inflation and higher interest rates inflows may not be forthcoming.''

India's current-account deficit, which includes trade and investment flows, widened to a record $17.4 billion in the financial year ended March 31, from $9.8 billion in the previous 12 months.

The current-account deficit may widen to as much as 2.6 percent of India's gross domestic product this year from 1.9 percent in the previous fiscal. Investments by funds abroad in local equities this fiscal year will decline to $5 billion from $29.4 billion in the previous 12 months, Harr said.

The spot rupee may outperform forwards traded in the offshore market, the bank said. Non-deliverable forward contracts show an implied rate of 43.08 for the rupee versus the dollar in six months.

``Relative to the forwards, the rupee is starting to offer value, though it may be too early to go overweight just yet,'' Standard Chartered's analysts said.

Forwards are agreements in which assets are bought and sold at current prices for settlement at a later-specified time and date. Non-deliverable forwards are settled in dollars rather than the underlying asset.

To contact the reporter on this story: Anoop Agrawal in Mumbai at aagrawal8@bloomberg.net.