Rupee's uptrend may not sustain

 

The massive foreign institutional investor (FII) buying of the recent past has pushed the rupee up from 62.30 against the dollar on February 20 to 60.70 on March 11. This is a seven-month high for the rupee. Normally one would say that is a strong buy signal for the rupee, but it may be unsustainable for a few reasons.

First, the American Federal Reserve is likely to accelerate the pace of tapering its balance sheet expansion because US employment has grown faster than anticipated in February. An accelerated taper would very likely, force up US Treasury yields, which in turn, would mean a strong dollar.

Second, it is in the Reserve Bank of India’s (RBI’s) interest not to let the rupee appreciate too quickly. The weaker rupee contributed substantially to the reduction of the current account deficits as the currency weakness made Indian exports more competitive and imports less attractive.

RBI can kill two birds with one stone as the rupee strengthens. The Indian central bank can buy dollar relatively cheaply to add to its reserves. It can thereby ensure the rupee doesn’t strengthen beyond a certain level which it considers acceptable.

A couple of other scenarios will bear watching. One is the oil marketing PSUs have to reverse the dollar swaps they were given last year, when the rupee was trending below 65 against the dollar. This will be in addition to their normal import requirements. The central bank (and every forex trader) will be looking for signs of rupee weakness if the oil marketing companies’ dollar demand (usually end-of-month) coincides with a period of FII selling.

A second scenario has to do with sector rotation within the stock market. The rupee has strengthened due to FII buying. This is a predictable situation and in specific terms, quite a lot of that buying has been directed, such as to capital goods, financials, oil & gas, which could benefit from the stronger rupee. Profits have also been booked in information technology and pharmaceuticals, two sectors that normally benefit from a weaker rupee. If the rupee moves in the opposite direction, there will probably be sector rotation all over again, with money flowing back into IT at the very least.

If the rupee hits resistance and the dollar starts a recovery, we could see several possible trades shaping up. The most obvious would be the long dollar-rupee trade, betting on the dollar going back to around 62.

The next possibility would be a long trade on the IT sector, especially on the highly liquid top-run stocks. HCL Technologies, TCS, Wipro, Tech Mahindra, Infosys, etc, have all been beaten down. Going long in these stocks could be highly profitable if the dollar snaps back.

The author is a technical and equity analyst