Strong dollar vs foreign inflows: Rupee in fine balance ahead of Fed meet

Analysts expect rupee to trade in the range of 78-80 per dollar, for now

Ahead of the crucial monetary policy announcement by the US Federal Reserve on Thursday, the rupee is delicately poised. Though some fundamental factors offer support to the domestic currency, the relentlessly strengthening dollar has clouded analysts’ view on the course of the local unit.

The US central bank is likely to raise interest rates by a minimum of 75 basis points (bps) again this week; around 30 per cent of traders in Fed funds futures predict a 100-bp hike.

The prospect of higher interest rates in the US has sent the dollar index soaring. So far in July-September, the dollar index has strengthened 5 per cent, making fresh 20-year highs. The rupee, on the other hand, has depreciated only 1 per cent against the dollar during the period, faring better than 10 emerging market currencies.

The rupee has not only enjoyed the protection of the RBI, which has aggressively sold dollars over the last past months, but has also been the beneficiary of a resumption of overseas investment flows since late July.

With $7.5 billion flowing into the equity markets since August and crude oil prices cooling off significantly, the broader picture is looking better for the rupee. The sticking point, however, is sentiment.

“The dollar’s strength against major currencies, such as the euro, JPY, and even CNY, has increased. From a sentiment perspective, things have worsened but from a flows perspective, I feel things have improved because oil has come down and capital flows have returned,” said Neeraj Gambhir, head of treasury at Axis Bank.

Gambhir, who expects the RBI to continue intervening strongly in the currency market, sees the rupee broadly trading near its prevailing levels over the near term. The domestic currency settled at 79.77 per dollar on Monday.

Ashish Parthasarthy, treasurer at HDFC Bank, said it is noteworthy that the earlier view of the Fed being compelled to reduce rates in the face of a recession now appears to be less convincing. He, too, spoke of contrasting factors influencing the trajectory of the rupee.

“The Fed has a long way to go and the dollar is extremely strong. At the same time, India is among economies that are witnessing high growth,” he said. “So, it will attract investment. Oil prices have also stabilised. Whenever there have been large inflows, the RBI has conducted a consistent strategy of absorbing them, because it knows that these are temporary and that these may flow out at some point,” he said.

Parthasarthy broadly sees the rupee in a range of 78-80 per dollar for now.

Within the overarching dollar strength, what may prevent the rupee from experiencing the sort of rapid depreciation it did in May and June (the currency lost close to 2 per cent in each of those months) is a wariness to bet against the rupee once it breaches the 80 per dollar mark, analysts said.

“Though we have hit $550 billion in forex reserves, we get the feeling that 80 is a sacrosanct level for the RBI. Even if it has to intervene and protect the rupee by selling another $8-10 billion, it may not mind, especially after the US CPI,” said IFA Global’s CEO Abhishek Goenka. Goenka predicts a range of 78.00-80.50 per dollar for the rupee. The rupee has only ever breached the 80/$1 mark three times, touching a record low of 80.13 on August 29.

But not all experts are confident of the rupee managing to breeze through the storm of a stronger dollar. Some currency experts pointed out that the resumption of overseas investment notwithstanding, a wider trade deficit shall result in net outflows from the country.

“On the flows story, while the resumption of capital flows makes the situation less unfavourable, we still see net outflows on account of the higher trade deficit,” said Anubhuti Sahay, Standard Chartered Bank’s head of economic research, South Asia.

“In our view, the pace of FX intervention is likely to slow down, allowing the rupee to depreciate in line with fundamentals. We maintain our forecast of the rupee at 81 per dollar by the end of this month,” she said.