A Bold Rupee vs. US Dollar Forex call from ING

The Indian rupee will slip 5 percent by December and resume a broader rally next year to climb to 38 per dollar by the end of 2008, a senior foreign exchange dealer with ING Vysya said.

The rupee, which was trading at 40.95 per dollar on Tuesday, has gained about 8 percent against the U.S. currency since the start of the year, propelled by strong foreign investment flows which have helped make it the best performing Asian currency in 2007.

"The export sector is suffering badly, and we should see the rupee fall a bit because of this," RK Gurumurthy, head of trading at ING Vysya, told Reuters in an interview this week.

Gurumurthy forecast the rupee would weaken to about 42.50-43.75 over the second half of the year.

India's widening current account deficit will also weigh on the local currency and it is overstretched according to real effective exchange rate (REER) indicators, he said.

"On an REER basis, anything above 15 percent is not comfortable. Even if you adjust some bit for the import duty cuts that are current, this level is a total aberration and could merit some attention."

According to a JP Morgan REER , the rupee is overvalued by nearly 16 percent.

The rupee touched a nine-year high of 40.28 per dollar in May and the Reserve Bank of India (RBI) has been intervening to keep it down. Gurumurthy said the RBI was likely to step up intervention efforts as easing inflation gave it more leeway to inject rupees into the system.

Latest data shows inflation fell to its lowest in 14 months on June 9 as the cumulative effect of previous rate hikes and a slew of supply side government measures helped subdue price pressures.

"For someone trying to bet on a weaker dollar and a stronger rupee, this could be a deterrent," he said.

Further monetary tightening appeared less likely with inflation trending lower and this could result in a slowing of capital inflows attracted to the relatively high-yielding local unit, he said.

The rupee is widely considered a beneficiary of the so-called carry trade, where investors borrow low-yielding currencies to fund investments in high-yielding assets.

But the rupee should bounce back early next year, Gurumurthy said, and its rally was likely to continue through 2008. Exporters should hedge themselves against future currency fluctuations this year while the rupee experienced a bout of relative weakness, he added.

"This is an opportunity for small and medium size enterprises to have a hedging mechanism or at least a proper hedging policy."