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The Federal Open Market Committee (FOMC) of the US Federal Reserve announced its policy decision and released the latest economic projections yesterday. While the Fed maintained status quo with respect to interest rate and asset purchases, the economic projections have taken centre stage. Inflation for 2021 has been revised upwards to 3.4 per cent from the March projection of 2.4 per cent, and the dispersion in the dot plot indicates rising likelihood of rates being raised in 2022 and 2023, a considerable upward shift from previous projections. The US dollar (USD) strengthened, and as a result, the dollar index posted an intraday gain of about 1 per cent, the highest daily gain since March 12, 2020. Dollar appreciating further would indicate a difficult period for the rupee.
As the dollar strengthened, the price of crude oil declined yesterday. However, this might be temporary and the price could begin to move up as demand seems to be improving. The US Energy Information Administration (EIA), yesterday, reported a decline in crude inventory to 7.4 million barrels over the week, higher than the expected drop of 3.3 million barrels. This is the highest drop in inventory since the last week of January this year. Although this is a US indicator, this can be a sentimental gauge and the steady decline in inventory means there is good demand, which can possibly push up the price. The inverse relationship between crude oil price and the rupee means that the rise in prices will weigh on the domestic currency.
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Rising crude oil price is also expected to push up inflation. The latest government data shows that the both Consumer Price Index (CPI) and Wholesale Price Index (WPI) have seen an uptick. The CPI inflation quickened to 6.3 per cent in May from 4.23 per cent in April and the WPI inflation hardened to 12.94 per cent in May from 10.49 per cent in April. Besides the crude oil price, the food inflation rose considerably, contributing to the overall increase in inflation. This can act as a drag on the local currency. Notably, 6.3 per cent CPI is above the Reserve Bank of India’s (RB) targeted level of 6 per cent.
What goes in favour of the rupee is strong foreign inflows. According to National Securities Depository Limited (NSDL) data, total net inflows from foreign portfolio investors (FPIs) in June stands at ₹14,497 crore. Equities attracted an inflow of ₹17,112 crore so far this month, and if this segment continues to perform well, more inflows can be expected which will act as a cushion for the rupee. The steady foreign inflows have resulted in the foreign exchange reserves hitting record highs. As per RBI data, total reserves stand at $605 billion, which includes foreign currency assets and gold. The reserves went past $600 billion for the first time ever. Higher reserves is a big plus for the rupee as this can be an effective tool in mitigating unexpected volatility in the exchange rate of USDINR.
Outlook
Strong foreign inflows and record foreign exchange reserves are encouraging factors for the rupee. However, rising crude oil prices and the consequent higher inflation, along with the rising dollar can have a negative impact on the rupee. Hence, in the short term, INR can be expected to move with a bearish bias which can possibly drag it towards 74 in the upcoming week.
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