Sensex and Rupee rally smartly, Dollar hit by Chinese comments

Swings in the rupee-dollar exchange rate may rise to a five-year high as the Reserve Bank of India struggles to simultaneously combat currency gains and inflation, UBS AG said.

Efforts to strike a balance between curbing consumer prices and the exchange rate in the face of surging capital flows will see the currency fluctuate in a wider band, Bhanu Baweja, UBS's London-based strategist, said in an interview. A theory of economics known as the `unholy trinity' argues that it isn't possible to have free movement of capital, a fixed exchange rate and an independent monetary policy at the same time.

``The `unholy trinity' really means that the degree of freedom for the currency should rise,'' said Baweja. He recommends buying the rupee and 12-month call options on the currency. A call option gives the right to buy the rupee and puts grant the right to sell.

Volatility on 12-month rupee options may rise to 8 percent, the highest since November 2002, from 6.7 percent now, said Baweja. Traders quote implied volatility, a measure of expected price swings, as part of setting option prices.

The rupee traded at 40.385 against the dollar as of 11:22 a.m. in Mumbai. Baweja expects the currency to gain as high as 38 over the next 12 months, the strongest since November 1997.

Rising Investment

Rising investment from overseas pushed the rupee to a nine- year high last month, forcing the central bank to step up dollar purchases and prevent the currency's advance from hurting exporters.

Net purchases of Indian stocks by global funds reached $10 billion this year through Aug. 6, surpassing $7.99 billion in 2006. Overseas borrowings by local companies increased six-fold to $16.1 billion in the year through March 31.

Foreign direct investment into India almost tripled to $15.7 billion in the year ended March 31 from the previous year, according to government estimates, and Trade Minister Kamal Nath aims to double it to $30 billion in this fiscal year.

The nation's currency reserves grew by $12 billion in the four weeks through July 27, twice as fast as in June, suggesting the central bank increased dollar purchases. Intervention increased money supply, stoking concern inflation will accelerate.

The central bank now needs to mop up the surplus cash from the banking system to keep inflation near a 13-month low of 4.03 percent reached in the week ended June 16. Governor Yaga Venugopal Reddy last week told banks to set aside more cash to cover deposits, and also scrapped the daily limit on the cash it drains through reverse-repurchase auctions.

``They need all the tools they can get,'' Baweja said. ``Demand remains pretty strong. We shouldn't forget foreign direct investment as a percentage of gross domestic product should be increasing at a faster pace as well.''

Rupee / US Dollar Forex Currency News, Gold in India, and The Sensex index on the Bombay Stock Exchange (BSE).
India’s Sensitive Index rebounded from its lowest level in a month yesterday on speculation the US government will take steps to stem mortgage losses that sparked a rout in global equities.
The Bombay Stock Exchange’s Sensex rose 29.74, or 0.2% to 14,932.77. The index has fallen 5.5% since the record 15,794.92 on July 24. on Monday, it closed at 14,903.03, the lowest since July 5.
The S&P/CNX Nifty Index on the National Stock Exchange added 16.85, or 0.4%, to 4,356.35.
The rupee rose 0.02% to 40.415 against the dollar at the 5pm Mumbai close.
Reliance Industries Ltd, India’s most valuable company, advanced.
“We are seeing a pull back after the recent declines,” said Soumendra Nath Lahiri, who helps manage $3.9bn of stocks at DSP Merrill Lynch Investment Management in Mumbai. “Still, the US housing problem is a worry and until that's sorted out markets will remain volatile.”
US stocks rallied the most in four years yesterday, led by financial companies, on speculation the government will take steps to limit mortgage losses. The rally in financial shares helped US stocks recoup $363bn of the $1.6tn wiped out since

Euro / Rupee and Yen / Rupee.
The government is thinking of another package of incentives for exporters hit by the appreciating rupee, Commerce Minister Kamal Nath yesterday said.

"We are thinking of a new package for exporters... the appreciating rupee has impacted exports and we are seized of the matter," he told reporters.

Nath said Prime Minister Manmohan Singh was keeping himself apprised of the situation and government was looking at measures on how to deal with it.

According to officials, Commerce Ministry has constituted a team to understand the impact of rupee rise at the ground level and some more incentives could be announced for exporters by August-end.

The rupee has appreciated from Rs 45 to a dollar in October-November last year to slightly over Rs 40 in July. The appreciating rupee has hurt growth in exports which has come down to 14 per cent in June from 23 per cent in April.

The government has announced fresh restrictions on external commercial borrowings (ECBs), limiting their use for rupee expenditure. Companies will now be able to raise only up to $20 million abroad for rupee expenditure and only with prior RBI approval.

All external commercial borrowings above $20 million will be allowed only for foreign currency expenditure. This means, companies can, at best, raise Rs 80 crore abroad via debt for domestic expenditure. For the rest, they will have to look for local financing. The funds raised abroad will have to be parked overseas till the actual requirement in India, an official statement said.

The overall goal is to prevent the external borrowing window from weakening the financial discipline sought to be imposed by the central bank’s monetary policy. Restricting the use of foreign borrowings for domestic expenditure had been one of the measures recommended by the Prime Minister’s economic advisory council headed by Dr C Rangarajan last month, to insulate the economy from excessive capital inflows.

This comes at a time when companies are facing higher interest rates at home and there is a growing demand for external funds to take advantage of the interest rate arbitrage. In May, the government had barred real estate companies setting up integrated townships from raising ECBs. It had also lowered the ceiling on interest rates to be paid on such borrowings, making it difficult for small and medium-sized companies to raise ECBs.

However, there has been no change in the provision allowing individual companies to raise up to $500 million through the automatic route. But now, they will be required to take RBI approval for raising funds above $20 million for rupee expenditure, an official said, adding that the move was aimed at restricting non-serious players going for such borrowings.

“ECB policy is constantly reviewed by the government in consultation with RBI to keep it in tune with the evolving macro-economic situation, changing market conditions, sectoral requirements, the external sector and the lessons of experience. Based on such review, it has been decided to modulate capital inflows through ECBs by modifying some aspects of the policy,” the statement said.

“The move is aimed at containing the huge inflow of dollars, which puts inflationary pressures on the economy. RBI has to release the equivalent of rupees to absorb the dollar inflow, so as to neutralise its effect on the money market. This leads to an increased money supply in the economy, adding to inflation,” PricewaterhouseCoopers executive director Sanjay Hegde said.

The dollar flow also drives up the value of rupee by creating more demand for it, he added. It may be pointed that companies raised ECBs amounting to $21 billion in 2006-07.

The government has already announced a Rs 1,400-crore package for exporters in July but it seeks to benefit only the employment-intensive sectors such as textiles, leather and small companies.

Now, the demand is coming from the sectors which have not been extended the benefits of the package for inclusion.