Rally in rupee is not surprising

The Indian rupee continued to strengthen sharply for the second day as foreign banks liquidated their long dollar positions aggressively after breach of critical levels.

At 3.35 pm, the rupee was trading at 65.63 a dollar, from its Tuesday’s closing of 65.82 a dollar. The rupee had closed at 66.61 a dollar last Friday, but the massive victory by the Bharatiya Janata Party (BJP) in Uttar Pradesh gave a thumbs up to India’s economic reforms agenda.

However, not everyone anticipated the rupee’s rapid rise against the greenback. Foreign banks had created stop losses at 66.30 a dollar level and then technical charts had shown key resistance at 66.10, 66.0 and then at 65.80 level. These levels were easily breached yesterday and new levels are being tested now.

“Both yesterday and today, the dollar selloff has been huge,” said a senior trader with a foreign bank. Nationalised banks were heavy buyers of dollars, but mainly to meet the year end client demand for the greenback. It is not clear if the Reserve Bank of India (RBI) has been intervening, by buying dollars to stem a sharp depreciation. But the pattern of appreciation and stability indicates that there is indeed some heavy chunk of dollar buying going on in the market, which is a sign of central bank intervention. RBI intervenes through a clutch of nationalised banks.

The US Federal Reserve is expected to hike rates on Wednesday and the dollar has weakened marginally, but those factors are already priced in and the market for now will ride on positive sentiments following BJP’s win in UP, dealers said. The dollar index has fallen about 0.13 per cent from Tuesday to trade at 101.57. However, at the start of the month, the index was over 102.

Already some currency consultants have given a call that rupee could strengthen beyond 63 a dollar level by June (https://tinyurl.com/hkvn2zx). Therefore, rupee’s strengthening bias can be expected to continue for some more time.

However, rupee’s strength was already predicted by rupee’s real effective exchange rate. The Bank for International Settlement (BIS) data showed that rupee was slightly overvalued, while the technical charts showed rupee must strengthen.

One important measure to gauge here is how much of inflow in a country is portfolio driven and how much is coming for the long term, through the foreign direct investment (FDI) route.

India’s current account deficit (CAD) as a percentage of GDP was 4.82 per cent at the end of 2012. At the end of 2016, the CAD was estimated to be at only 0.6 per cent of GDP. This marked improvement in the deficit has also meant that the rupee has remained one of the most stable currencies in Asia. In fact, the deficit reduction is way better than what the International Monetary Fund had expected from the country.

The IMF had in 2013 said India’s norm CAD is 3.4 per cent of GDP. The norm CAD, also called structurally sustainable CAD, was revised down to 2.5 per cent of GDP in 2015. The norm indicates the permanent current account deficit of a country. But India’s CAD at 0.6 per cent is way above that bar. Norm CAD reflects an intrinsic value and not necessarily the actual value of CAD.

This indicated that rupee was actually fairly valued with bias towards strength (https://tinyurl.com/jpgw7um).