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Rupee at 2-year high of 63.60: Why did it surge and what's next?

Rupee has strengthened 6.21% against the greenback, year till date as FPIs have been pouring in money

Abhishek Goenka 

An India Rupee note is seen in this illustration photo June 1, 2017. Photo: Reuters/Thomas White/Illustration/Files

The finally broke through the key psychological level of 64 after spending a good four months in the 64-65 range. The made a low of 63.60 on Wednesday, a level not seen since July 2015. Despite a muted reaction in the equity and bond markets the strengthened as the market was eyeing 64 as the key support level and huge stops were triggered as that level broke. has strengthened 6.21% against the greenback, year till date as FPIs have been pouring in money into Indian equity and debt markets in search of yields. Low inflation in the US and inability of Trump administration to push through anticipated fiscal reforms has caused the US yields to drop and US Dollar to underperform.

While stronger would keep imported inflation under check, any relative outperformance from here on, on a trade-weighted basis would hurt export competitiveness. Currencies like the Chinese Yuan, Indonesian Rupiah, Philippine Peso have strengthened much less in comparison to the The central bank thus far has allowed the to appreciate broadly in line with other Asian and emerging market currencies by absorbing Dollar inflows. By doing so its FX reserves have swelled to 390Bn. Going forward, the central bank is likely to continue to manage the on a trade-weighted basis as it would be mindful of Indian exports becoming uncompetitive and domestic producers suffering on account of cheap imports. If and only if broader weakness continues, could continue to appreciate towards 63.00 in the medium term. The factors that could cause the weakness to reverse would be passage of fiscal reforms in US and/or a pick up in inflation and wages in the US or escalation of geopolitical tensions. A hawkish Fed and higher US rates could cause the liquidity tide to reverse resulting in hot money flowing out of EM assets. 

On the domestic front, several big ticket IPOs are queued up and inflows into equities (primary market as well as secondary market) could continue to remain robust if global risk sentiment remains positive. India is being viewed as a preferred investment destination on account of macroeconomic reforms such as demonetization and implementation of GST. Despite the rate cut, Indian bonds offer an attractive yield pick up for FPIs especially with the being stable since most positions remain unhedged. It would help to track the onshore-offshore (NDF) forward point differential to get a sense of risk sentiment among FPIs. The greater the spread, the more content the FPIs are selling the USD/INR pair for carry. Its best to be short USD/INR for exporters for long term and earn carry - the strategy seems to pay off last 4-5 years. Only if we see a close above 64.40 we can assume a reversal in the A note of caution being that August has historically been a month when tends to depreciate. It will be interesting to see if that seasonality plays out this time as well.
Abhishek Goenka is CEO, IFA Global

Disclaimer: Views expressed are personal. They do not reflect the view/s of Business Standard.

First Published: Thu, August 03 2017. 09:10 IST