The Budget announcements by Finance Minister Arun Jaitley on opening 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 hiked 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 selected 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.
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.
The report, however, said in the short-term rupee-dollar dynamics remain heavily influenced by the RBI’s vigorous foreign exchange policy.
Data on the RBI’s forex forward book suggests that forex intervention in May was around USD 20 billion. The report estimates June intervention to be around USD 7 billion and total RBI intervention in recent months could easily have exceeded USD 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.