In line with several other Asian currencies, the rupee has tumbled in value over the past couple of months, hitting a record low of Rs60.86/US$ on July 8. Its slide was triggered by the ramifications of an early tapering of US bond purchases, which led to a broad upturn in US dollar demand and a rout in high yielding assets worldwide. Critics warn that the Indian currency is prone to volatility and could be harder hit due to fragile investor confidence, a lack of specific action on structural reforms and weak domestic fundamentals. Early indicators for Q2 – notably services – have continued to disappoint, following a sluggish Q1 performance, in which the economy expanded 4.8% (y-o-y). In addition, tighter liquidity conditions and a rapid slide in the rupee have cut the appetite for Indian fixed income and equity assets, raising questions about the funding of the large current account deficit, which exceeded US$85bn in FY2012. The shortfall narrowed in Q1 but may worsen in Q2, after the merchandise trade deficit leapt in April on a surge in cheaper gold imports. Yet it should be contained by softer household consumption, government efforts to curb demand for precious metals via higher import duties and a more competitive currency. The Reserve Bank kept rates unchanged at 7.25% last month, but monetary loosening may continue after inflation, measured by the Wholesale Price Index, dropped to 4.7% (y-o-y) in May, from more than 7% in February. On balance, the consensus is predicting that the rupee will recover somewhat over the next twelve months.
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