Rate cut expectations push rupee to a new low despite falling dollar index

The rupee depreciated to a new intraday low of 87.49 against the dollar on Wednesday, due to expectations of a 25 basis points (bps) rate cut by the Reserve Bank of India (RBI) this week, before ending the day at a new closing low of 87.46.

 

There was strong dollar demand from importers as a rate cut would put further pressure on the Indian unit.

 

The meeting of the RBI’s Monetary Policy Committee (MPC), which sets interest rates, is underway and the outcome will be announced on Friday.

 

Despite a weaker dollar index and stronger Asian currencies, the rupee depreciated due to stop-loss triggers, said dealers.

 

State-run banks were spotted selling dollars on behalf of the central bank in the foreign exchange market, helping prevent further depreciation of the rupee.

 

The local currency settled at 87.46 per dollar on Wednesday, against 87.12 per dollar on Tuesday.

 

“We maintain our base case in which the RBI meets expectations but does not over deliver,” Nomura said in a report.

 

“While we believe the RBI has become more tolerant of FX depreciation, as its focus has shifted towards supporting growth, the global backdrop remains fluid. And, at this juncture, the RBI may err on the side of caution,” it said.

 

With the rupee approaching 87.50 per dollar, there was uncertainty about the next resistance level, as volatility remained high, partly due to global trade tensions, said market participants.

 

“The market has now started factoring in a 25 bps rate cut that led to positioning accordingly. The RBI was there at around 87.30 per dollar level, but stop losses were triggered and we were very near the 87.50 level,” said the treasury head at a private bank.

 

The rupee was among the worst performing Asian currencies on Wednesday, with 0.4 per cent depreciation observed during the day. South Korean won, Philippines peso, and Malaysian Ringgit depreciated by 0.5 per cent.

 

The dollar index was down by 0.4 per cent to 107.60 on Wednesday. It measures the strength of the greenback against a basket of six major currencies.

 

Market participants said that the rupee might witness 88 per dollar mark if the domestic rate-setting panel delivers rate cut on Friday.

 

“The 87.50 level was almost touched on Wednesday. The 88 per dollar is not far. We may see it on Friday if a rate cut happens,” said a dealer at a state-owned bank.

 

A key concern was the RBI's stance on the rupee being overvalued, implying further depreciation. Market participants expected the rupee to reach 87.50 by March-end, but it depreciated sooner than anticipated, reflecting heightened volatility.

 

The local currency has depreciated by 4.64 per cent in the current financial year, whereas the current calendar year has witnessed 2.12 per cent depreciation. In February so far, it has fallen by 0.97 per cent.

 

The rupee had breached the key 87 per dollar mark on Monday as the dollar strengthened after US President Trump slapped tariffs on Canada, Mexico and China.

 

Meanwhile, net liquidity in the banking system improved to a deficit of Rs 38,215 crore on Wednesday.

 

The RBI had announced a series of measures to inject durable liquidity into the banking system after the net liquidity deficit had widened beyond Rs 3 trillion.

 

The measures included open market operation (OMO) auctions of Government of India securities totalling Rs 60,000 crore in three tranches of Rs 20,000 crore each on January 30, February 13, and February 20.

 

Additionally, a 56-day variable rate repo (VRR) auction for Rs 50,000, crore, is to be held on Friday, and a dollar/rupee buy/sell swap auction of $5 billion for a six-month tenor was conducted on January 31.

 

“The measures taken by the RBI helped the liquidity situation, but we need further efforts to make liquidity comfortable. Otherwise, there would be issues in transmission of the rate cut,” said the treasury head at a private bank.

 

RBI had reduced banks’ cash reserve ratio (CRR) requirement in December by 50 bps, which released durable liquidity of Rs 1.16 trillion.

 

The market believes that the RBI would keep another CRR cut as its last resort.