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Cross Currency | Is long term rupee weakness evitable?

The USD-INR remained in a narrow range during the week despite the hawkish statement by the US central bank; after opening at 73.81 the pair traded between 73.57 and 73.93 before finally ending the week at 73.69. Although the dollar index moved higher initially due to the risk-off mode caused by the default concerns of China’s Evergrande Group, it retraced marginally from its recent highs by the end of a week that was dominated by central bank meetings across the globe.

During its latest policy meeting, for the first time since it started to buy bonds to induce liquidity into the economy derailed by the Covid crisis, the Fed gave a distinct clarity on the reduction of its bond purchase programme and even gave a timeline for ending it by the middle of next year. Alongside, the dot plot indicated that the chances of a rate hike in 2022 have also increased as out of 18, 9 members expect a rate hike next year vs 7 in the July meeting.

This increased rate hike expectation was mirrored immediately by the surge in the US treasury yields. Interestingly, the Fed has lowered the growth projections while it has increased the inflation expectations. Meanwhile, like the Fed, the BOE also suggested that it can bring the government bond-buying to an early end, in fact, the expectations of an interest rate rise by the UK central bank has moved as close as March 2022.

On the domestic front, while the buoyant equity markets and the recent policy push by the central government in the form of 100% FDI in few sectors along with the implementation of PLI schemes and other reforms helped the Indian Rupee to withstand the US dollar strength to some extent, the risk on-off saga prevented any major sentimental boost and subsequent gains in the local currency.

Even historically speaking, we can note from the chart below, that despite the fact that India has been a sought after economy by many overseas investors due to favourable structural changes, the Indian rupee has failed to amass the benefit from ever-increasing Foreign Direct Investments (FDI) into the economy. FDI has increased from about USD 24 billion in FY14 to USD 60 billion in FY21 with an average annual increase of USD 4.3 billion over the period. Interestingly, a look at the current FY tells a similar tale, an FDI inflow of about USD 17 billion in the first quarter could not prevent a 1.5% depreciation in the Indian Rupee. Notably, the dollar index which can be used as a barometer to gauge US dollars’ global strength decreased by only 0.40% during the same period.

Rupee chart1

The fact that we still remain an import-dependent economy doesn’t help the Indian Rupee’s cause either; the current account surplus seen in the last financial year is a rare phenomenon, more importantly, the surplus cannot be attributed to a robust exports figure, it is more so because the imports have slowed down due to dip in domestic consumption amid the pandemic.

It is clearly evident that the inherent nature of the Indian Rupee has been to depreciate against the dollar with intermittent corrections and will continue to be so. The major reason for this is the age-old fact that a high inflation rate will continue to reduce the value of any currency; Indian inflation rates like most emerging market economies have been higher than that of the US.

Coming back to the current market situation; an increase in volatility is anticipated over the looming tensions of default by Evergrande. While a portion of analysts believe that the Chinese government will bail out the world’s most indebted ($300 billion) real estate company in some form or other, many even feel that China will let overseas bondholders swallow the losses. Default fears have increased this week as the company missed its deadline to pay the interest on Thursday and currently having a 30-day grace period to clear it.

Keeping in mind the above near term risk factors in conjunction with the upbeat domestic equities, we can expect choppy movement in the USDINR pair between 73.30 and 74.30.

The authors, Ritesh Bhansali and Imran Kazi are both VPs at Mecklai Financial. Views are their own)

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