Currency Corner by Vatsal Srivastava


Vatsal Srivastava says there is limited upside left for Indian rupee against dollar 

Indian RupeeThe Indian equity market party is showing no signs of losing steam with the benchmark indices closing at an all time high yet again Monday. However, the Indian Rupee will not be a guest at this party for long. This column believes that there is very limited upside left for the Rupee to appreciate against the US Dollar.

It would be safe to assume that the USD/INR pair will not breach the crucial 58 level over the medium term. This is also the level the Reserve Bank of India (RBI) would be comfortable buying Dollars to recoup its foreign exchange reserves.

Strong foreign funds flows have been a major pillar supporting the recent bullish attitude towards the Rupee. Falling crude prices on the back of more stable geopolitical news flow and the continuation of gold import curbs has allowed the Rupee to inch towards the all psychological 60 mark to the greenback.

Currency Corner has argued over the past several months that the implications of the US monetary policy normalization have not yet played out in the financial markets. But they will sooner or later as the divergent paths of major central banks are increasingly becoming clear.

Last week, the European Central Bank slashed its deposit and refinancing rate by 10 basis points and announced the launch of a stimulus program which would involve purchases of Asset Backed Securities (ABS) and covered bonds. One of the primary purposes of these programs is to weaken the Euro to boost the ailing exports. Further, the sales tax hike has had a much more severe impact on the Japanese economy than many had expected.

The Bank of Japan’s October monetary policy meet will look to address these issues and possibly even hint at additional quantitative easing. Thus, on the back of these two events, the Euro has broken the major support of 1.3 against the US Dollar and the USD/JPY pair is trading above 105.5. The net long positioning in the US Dollar Index according to US-based Commodity Futures Trading Commission (CFTC) data is at a multi month high.
The value of the dollar’s net long position surged to $35.88 billion in the week ended Sep 2, from $32.92 billion previously. Last week’s net long contracts in the US dollar were the biggest since the week of June 4, 2013. On the back of these moves, the Rupee has hugely outperformed other DM (Developed Market) and EM (Emerging Market) currencies.
However, going forward, if the US Dollar continues to strengthen and US 10 year yields head higher, we can expect the Rupee to hover around the 63-64 levels. As Bank of America Merrill Lynch point out in their research note, one should not expect the RBI to fight a rising US Dollar, although USD-INR accounts for 85 percent of India’s trade. It is not possible for it to offset cross-currency pressures from the US dollar given limited FX reserves.
On the other side, every dip will be used to recoup FX reserves. Bank of America Merrill Lynch estimates that the RBI will buy $35-40 billion by March, 2016 to maintain an eight month import cover. Thus, they are expecting the USD/INR to trade between the range of 58-62.
Further, if this range is broken it would likely be to the upside. If the US economy recovers faster than expected (although the latest jobs data was soft), we could see the US Dollar Index heading towards 86-87 and the US 10 year yields around 2.9 percent by early next year. In such a scenario, we can expect the Rupee to trade around 64-65 to the greenback.
The current up-move of the Rupee is coming to an end and the risk reward for Rupee bulls is stacked against them for the near term.

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