January went by pretty much as expected: hemmed in by the RBI on both sides. Seeing a trading top around 83.30 right at the start of the month the Rupee managed to gain 50 paise for a brief moment in time as it opened one morning at 82.80 before returning to the 83.20 region. It has closed January at 83.05 having bored everyone to tears in the interim.
We stated last month that the best way to predict what the Rupee will do would be to be able to read the mind of the RBI since they are in super-hyper-micro-management mode just at the moment. From September they have been in an ‘accumulate to protect’ frame of mind- the protection having a double purpose of sheltering the domestic currency from the various geopolitical storms raging and the uncertainties of the US rate policies that are affecting both capital and trade flows- to India and its neighbouring region.
The Dollar actually began slightly bullish as safe haven buying prompted by equity market nervousness reduced risk exposure at a time of multiple uncertainties- both economic and geopolitical. On the economic front Chinese debt linked to property behemoths Evergrande Holdings and Country Garden Holdings with combined outstanding debt of USD 540 billion began to look precarious. This fear was borne out by the liquidation proceedings begun by a Hong Kong court against the former in the last week of January.
At play also, is the next move by the Fed. Even though the direction is pretty much certain, the timing- crucial information for the market in general, is uncertain; all the central banks who are being forced to defend their currencies from capital outflow by keeping their rates at an elevated level are anxiously awaiting clarity.
The geopolitical front sees the possible widening of the Israel destruction of Gaza as other parties seek to get involved to help the Palestinians- a move that the United States stands ready to oppose with armed force.
Any strength displayed by the Rupee mid-month has been quickly used to mop up Dollars by the RBI whose Foreign Currency reserves keep rising (it rose USD 4.47 billion in the week ending 22nd December- the same week we saw 82.80 tested briefly). Thereafter 83.20 provided resistance for Dollar buyers as the RBI was keen on holding it steady.
Looking ahead this sideways range trading scenario is going to continue until a few economic and political factors are clearer or resolved. The first- and arguably most crucial is the Federal Reserve Board’s rate policy meeting that just concluded last night. Post the meeting Federal reserve Chairman Jerome Powell effectively killed speculation that rate cuts would begin at their next meeting (they remained unchanged for the 4th time in a row last night). This has pushed global equities a little lower and increased the possibility of a minor recession in the US later this year- even though economic data belies the expectation. This decision will factor into the RBI decision on rate cut timings: the obvious move would be that they also postpone any local rate cut. Critically for the Rupee, this increases the likelihood of them continuing to buy USD in the spot market for a while longer in order to hedge against investment outflows.
After this is the policy announcements in the Indian Budget which will impact foreign investments and so foreign currency flows. The commitment to reducing the fiscal deficit this year to 5.1% will be seen as bullish by debt investors and may add to the expected inflow into the debt market as inclusion of Indian G-Sec in the Morgan Stanley Country Index for bonds kicks in. The focus on improving delivery mechanisms in all facets ranging from tax refunds to port turnaround times will also no doubt help in attracting investments.
The ongoing Chinese debt market chaos also needs to be monitored for potential spill-over impact. It has prompted large scale government intervention in the financial markets, part of which is the freeing up of statutory liquidity held by banks to the tune of USD 140 billion- part of a USD 278 billion stock stabilization package. Freeing liquidity is the exact opposite of what all other central banks are doing globally- including the RBI, and this may affect how the Chinese Yuan behaves and- consequentially, how the Rupee reacts. If the Yuan loses ground on greater liquidity/ lower rates, the RBI may be forced to maintain Dollar support locally against the Rupee.
In terms of the geopolitical situation there are risks that are unquantifiable in the sense that it is hard to put either probabilities or market reaction to them. If the current conflict in Gaza were to escalate into a wider regional conflict all bets would be off in terms of market lows as risk-off policies would mean withdrawal from Emerging Markets. Although, if that were to happen then it would be quite likely that rate cuts would happen faster and bonds would rally even if equity suffered. Other than that, the other political risk on the horizon is, of course, the outcome of the national elections in India, the dates of which will be announced soon. This is yet another reason that the RBI may continue to hold the Rupee rangebound rather than let it whip around as general uncertainty abounds.
The view for the Rupee remains difficult to forecast. On balance, however, the risk is for the RBI to continue to maintain its iron grip on the currency pair. Disregarding the continuing moves towards alternate currency usage (de-dollarisation in other words) which can still involve RBI intervening through the USD and then switching to Gold or other currencies, the RBI is- on balance, likely to continue buying and keeping the Dollar well bid.
We would suggest a RBI directed range of 82.80-83.20 continuing. Any exogenous shock could take us to 83.50 for a short-term spike. A lower probability can be assigned to the downside as long as the RBI keeps mopping up Dollars at a decent clip.