The Indian Rupee may depreciate by around 20% during next two years on account of dip in confidence about the domestic economy leading to outflow of funds.
According to a report by financial and business reserach firm Evalueserve, there will be pressure on the Rupee unless steps are taken to fix certain structural issues like high current account deficit and dwindling investments.
"During the next two years the probability of the INR (Indian Rupee) to depreciate is the highest (about 50 %) as compared to an appreciation or a status quo scenario," Evalueserve said, adding that the depreciation could be in the range of around 20 %.
During the past 12 months, the INR has traded in a relatively narrow range between 47.33 and 43.99 to the USD.
"However, the pressure on its stability seems to become more evident," it said.
Evalueserve said INR's depreciation could be fuelled by exit of FII money and lack of investor confidence on account of governance issues, besides high current account deficit (which is the net flow of income out of the country, barring capital movements).
"Even a relatively orderly outflow of USD 15 billion of FII money over a year could result in the INR depreciating by 22-30 %. This could imply an exchange rate in the range of INR 55-60 to every USD," it said.
The situation could be even worse in case the outflow in more faster.
Foreign funds have pulled out nearly Rs 3,400 crore from the Indian stock market during the first half of May as interest rate pressures continue to mount.
"This risk (outflow) is also heightened by the fact that India's capital markets are very shallow and do not have the capacity to absorb even moderate external shocks," it said.
Evalueserve pointed to structural factors like the high inflation, which has been blamed on supply side challenges, problems of governance as shown by recent scams, and high deficits.
"Inflation is at an all-time high... The monetary policy changes undertaken by the government to control inflation have been ineffective," the report said, attributing inflation to supply side challenges including lack of infrastructure.
It said that India is the only BRIC economy where Foreign Direct Investment (FDI) has shown a fall.
FDI fell to USD 19.4 billion in 2010-11 from USD 25.8 billion in 2009-10.
"This is troubling as FDI is an important indicator of investors' faith in a country's long-term prospects. Foreign Institutional Investment has been buoyant, but these funds are volatile by nature and are prone to 'flight risk' at the first signs of trouble, something that happened during the financial crisis," Evalueserve said.