Weakness in rupee to continue, may end 2012 at 57 against USD

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The weakness in Indian rupee is likely to persist for some time and the home currency is expected to end the year at around 57/USD as the conditions necessary for lifting up the rupee are not in place, says a research note by HSBC.

"We still expect USD-INR at 57 by year-end, but the risks are rising that the exchange rate could overshoot," HSBC said.

The rupee has already weakened by nearly 30 per cent against the USD since July last year and on Friday it fell to an all-time low of 57.37/dollar (intra-day) and ended the day at 57.15.

Weakness in the rupee is likely to remain given the lack of a clear plan for improving the investment environment and bleak fiscal outlook, HSBC noted.

Though some reformatory measures could be announced early next month, "there will be questions about the substance of any potential measures," it added.

The research note added that domestic factors like the uncertainty in the investment environment and the large fiscal deficit are the primary factors behind the weakness in the rupee and these are more important than the external scenario.

Moreover, the report said that the Indian government has been 'flip-flopping' on its economic reforms and cited the recent back tracking by the union government on its plans to open up FDI in the retail sector and a delay in increasing foreign investors' ownership in the insurance sector.

"These indecisive actions by the authorities have created an uncertain regulatory environment for foreign investors. As a result, capital account flows into India have slowed," HSBC said.

India has already witnessed equity outflows of USD 225 million since the start of April. Although this outflow has been small, deteriorating global conditions suggest the risk of capital repatriation out of India is 'high'.

"For INR to strengthen more meaningfully and sustainably against the USD, the government needs to undergo the necessary structural reforms," HSBC said.

Meanwhile, the RBI has not been intervening aggressively through the course of this year to strengthen the rupee and has only sold USD 5.4 billion in 2012, a very small amount given the big move in the currency.

The lack of action from RBI could be due to the fact that India has relatively low reserves adequacy and also faces liquidity tightness in the banking system, HSBC said.