Rupee Rally at Risk to Goldman as India Boosts Reserves

India is cashing in on the rupee’s region-beating rally to boost its foreign reserves, prompting banks from Goldman Sachs Group Inc. to HSBC Holdings Plc to predict an end to the currency’s gains.

The rupee will reverse this month’s 2.1 percent advance and tumble more than 3 percent to 61 per dollar by year-end, the sharpest decline among 11 Asian currencies after the yen, according to Bloomberg strategist surveys. HSBC forecasts a drop to 62 by Dec. 31, while Goldman Sachs sees the rupee at 61 in six months.

Reserve Bank of India Governor Raghuram Rajan has used the stronger rupee to buy foreign currency, pushing reserves above $300 billion for the first time since 2011 and bolstering the nation’s defenses against speculators. Currency analysts are speculating the policy will outweigh the foreign investment lured by the election campaign of pro-business politician Narendra Modi, who was confirmed as prime minister this month.

“We would caution against the conclusion that positive politics will translate into large gains for the currency,” Mallika Sachdeva, a Singapore-based strategist at Deutsche Bank AG, the world’s second-biggest foreign-exchange trader, said May 28 by e-mail. “The RBI will be opportunistically buying dollars. India’s reserves buffer, while large in absolute terms, is still weak versus regional peers on metrics like import or short-term debt cover.”

Modi Inflows

Revived confidence in Indian assets during the election campaign prompted foreigners to pump $14.6 billion into the nation’s stocks and bonds this year, exceeding inflows of $12 billion in the whole of 2013. The rupee surged almost 5 percent against the dollar since Dec. 31, the best performance after Brazil’s real of 24 emerging-market currencies tracked by Bloomberg.

The rupee has already retreated more than 1 percent from an 11-month high of 58.335 per dollar reached May 23 and traded at

59.1025 as of 1:19 p.m. in New York.

Bank of America Corp. says India will have to keep building its reserves because they’re still only enough to pay for eight months of imports, the lowest coverage ratio since 1996.

“We expect Governor Rajan to continue to buy foreign exchange to improve import cover that’s almost halved in the past six years,” Indranil Sengupta, a Mumbai-based economist at the U.S. investment bank, said May 27 by phone. “We calculate the RBI needs to buy $80 billion in the next two years to just maintain that import cover.”

Deploying Gains

India’s not the only developing country to parlay local-currency gains into foreign reserves in anticipation of an end to the U.S. Federal Reserve’s monetary stimulus program. The 12 emerging markets with the biggest stockpiles outside of China lifted their combined holdings to $2.97 trillion as of May 26, about the most since Bloomberg began compiling the data in 2008.

India boosted its reserves to $315 billion, $6 billion short of a record reached in September 2011, as the rupee rallied from an all-time low of 68.845 per dollar in August.

RBI intervention will merely “limit the pace of rupee appreciation,” Hamish Pepper, a Singapore-based strategist at Barclays Plc, said in a May 28 client note.

The British bank raised its six-month rupee forecast to 59 per dollar, from 61 previously, citing a strengthening economy and fund inflows. Nomura Holdings Inc. lifted its year-end prediction to 57 after the election, from 59.5.

The victory of Modi’s Bharatiya Janata Party stoked optimism that India will be able to take measures to cut its current-account deficit, after the nation’s last prime minister passed the fewest bills for any government to have completed a five-year term. The shortfall in the broadest measure of the country’s trade narrowed to $32.4 billion in the fiscal year ended March from an unprecedented $88 billion in the prior period.

Policy Switch

A 30 percent plunge in the rupee from 2011 through 2013 as the deficit widened prompted the RBI to prop up the currency last year by tightening the cash supply, raising interest rates and selling banks discounted foreign-exchange swaps.

Goldman Sachs sees the central bank’s influence on the rupee as being negative this time around.

“The RBI has said that it wouldn’t want the gains on the current account to be lost due to a strengthening currency, which would reduce competitiveness,” Goldman Sachs analysts including Mumbai-based Tushar Poddar wrote in a May 22 report.

The RBI’s increasing war chest will limit the rupee’s short-term gains to 57, and the currency will fall to 61 by year-end as the post-election rally fizzles out, according to Credit Agricole SA.

“The market has roped in too-high hopes about Modi,” Dariusz Kowalczyk, a strategist at the bank in Hong Kong, said in a May 27 phone interview. “There will be disappointment.”

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