BANGALORE The rupee's recent rally is set to reverse course later this year as upbeat sentiment ahead of a general election wears off and economic growth remains slow, a Reuters poll found.
Still, the rupee will not lose much and is expected to trade at around 60.61 to the U.S. dollar in a month before weakening further to 62 in a year, Thursday's poll of 30 currency strategists showed.
Expectations that the pro-business opposition Bharatiya Janata Party (BJP) will win the election and, in turn, attract more investment is in part responsible for the benchmark BSE Sensex hitting a new lifetime high of 22,620.65 on Thursday.
The rupee reversed last year's losses of more than 11 percent against the U.S. dollar and has gained over 3 percent so far this year. It hit an eight-month high of 59.57 to the U.S. dollar on Wednesday.
That is well above the near-18-year low of 68.80 that it hit last August when a sell-off by investors battered the rupee along with other emerging market currencies.
That sell-off was mostly in reaction to the U.S. Federal Reserve's plan to taper its massive stimulus programme, which made investors dump riskier assets, including the rupee, combined with a slowdown in India's economic growth to a four-year low.
While investor sentiment has since improved, strategists do not expect the rupee's strength to continue.
"The kind of (rupee) appreciation we are seeing today is more because of foreign institutional investment flows which are fairly gung-ho because of elections and what they perceive would be a strong, favourable government inclined towards economic growth," said Madan Sabnavis, chief economist at CARE Ratings.
"Right up until the time when the election results come out, things will remain positive. Then, I think we will probably get back to reality and see what kind of a government comes in and how differently are they able to do things."
Indeed, the new government will be faced with the same challenges as the current one - high inflation and borrowing rates, weak industrial production and muted demand.
The ruling Congress-led coalition government has been under severe criticism for its inaction over pursuing key reforms, which has hurt economic growth and investor sentiment.
Traders have also speculated that the Reserve Bank of India has been buying dollars recently to shore up its foreign exchange reserves and possibly capping the currency's strength.
RBI Governor Raghuram Rajan told a TV channel on Wednesday that a "substantial" strengthening in the rupee to 45 or 50 per dollar could hit exports, but added that the central bank was fine with a "certain amount of leeway" in the currency.
On Tuesday, the RBI left its key repo rate unchanged at 8 percent and said it would keep rates on hold in the near term if inflation eases further.
The Fed will likely raise its key interest rate in the second half of 2015, according to top Wall Street economists polled by Reuters. That will also help the dollar gain and, in turn, push the rupee lower.
"Over time, the Fed's policy shift is supportive of the dollar and that's the most important reason why we see some weakness in the rupee," said Nick Bennenbroeck, head of currency strategy at Wells Fargo Securities.
(Polling by Shaloo Shrivastava and Swati Chaturvedi in Bangalore; Editing by Jacqueline Wong)