The Budget announcements by Finance Minister, Arun Jaitley, on opening the defence and insurance sectors to higher FDI will attract more foreign investors which will help in strengthening the rupee, says a report.
The maiden Budget of the Narendra Modi Government has hiked the foreign direct investment limit in insurance and defence sectors to 49 per cent from 26 per cent.
It also proposed tax incentives for two new investment instruments — REITs and InvITs — to help attract long-term funds from foreign and domestic investors, including NRIs.
“The authorities’ intention to promote FDI in select sectors and initial specific steps to ease rules in defence, insurance and real estate will likely improve international investors’ assessment of the macroeconomic policy,” British brokerage Standard Chartered said in a report.
FDI inflows
These measures will boost the government’s ability to bridge any short-term current account financing shortfall with new FDI inflows, it said.
“It also opens up the prospect of an improved economic performance in medium-term, which may create the conditions for more strengthening of the rupee,” the report said.
Rupee-dollar dynamics
The report, however, said in the short-term the rupee-dollar dynamics remain heavily influenced by the RBI’s vigorous foreign exchange policy.
Data on RBI’s forex forward book suggests that forex intervention in May was around $20 billion. The report estimates June intervention to be around $7 billion and the total RBI intervention in recent months could easily have exceeded $30 billion.
“Given the scale of this intervention and only modest new budget measures, there is the danger of a short-term rupee liquidation dynamic which would see USD-INR rebound decisively back into the RBI’s “fair value” zone,” the report said.
According to RBI, the fair value of the rupee is in the 60-62 range.
Given this liquidation threat, StanC maintains a short-term neutral recommendation for the rupee, but will look for opportunities to switch to overweight on any significant rupee appreciation.