Rupee can slip 3% more; rate cut, regulatory intervention needed

The mayhem and bloodbath in domestic assets continues on as Coronavirus (COVID-19) spreads. The World Health Organisation (WHO) has declared the health scare a pandemic. There is extreme panic and risk aversion at this point in global markets. The US President Trump has restricted all travel from Europe for the next 30 days saying many Coronavirus cases in the US were seeded from Europe. India has suspended all tourist visas till April 15, 2020. We might now see more stringent travel and trade restrictions globally. 

In the past few sessions, the move in the Rupee has been largely offshore driven, taking precariously close to a new all-time low of 74.48 against the US Dollar. The offshore bid has percolated to onshore. USD-INR spot onshore has been constantly bid as arbitrageurs have been seizing the gap between offshore and onshore forward points, which is around 25 paise right now. The volatility term structure has inverted further with one-month at-the-money forwards (ATMF) volume at 8.4% and three-month ATMF volume at 7.2%.

The FII flows have been on a negative side witnessing outflow worth Rs 14,194 crore ($1.9 billion) from combined debt and equities segment this month so far. Foreign investors holding stocks on delivery might have certainly done a long put to hedge their positions.

India’s central bank said it was monitoring global & domestic developments closely and is ready to take appropriate action. So far, India's case count has been 73 but no fatality been declared yet. However, if coronavirus induced disruptions exacerbate, we may see a follow-up move in USDINR to new all-time highs. 

Crude Oil prices have fallen to multi-year low. A $10 per barrel fall in crude prices has the following repercussions for the domestic economy.

Monthly imports reduce by roughly $1 billion. Since crude has fallen by $20 per barrel, it would reduce the monthly bill by $2 billion and annual import bill by $24 billion. Headline inflation will also ease by around 0.5%. This would give the RBI leeway to cut rates by at least another 50 basis points (bps). We expect the inflation to revert to 3.5-4% level with a good Rabi harvest and lower crude prices.

While lower crude prices are Rupee supportive, outflows from capital markets on risk aversion would offset that. If the currency breaks 74.50, we may see 2 – 3% depreciation from the breakout point. Along with rate cut, regulatory intervention will be required to halt steep depreciation in the rupee, considering the robust FX reserves RBI possesses.

Abhishek Goenka is Founder and CEO, IFA Global. Views are his own.