Rupee appreciates on expectations of weak dollar, global risk sentiment

The rupee could see an appreciating bias on expectations of a weak dollar and global risk sentiment, channelising the greenback towards high-yielding assets and keeping domestic financial markets supported, say experts.

The domestic unit has appreciated about 60 paise vis-a-vis the dollar so far this month. It has strengthened from 73.95 per dollar on May 3 to 73.355 on May 10.

Abhishek Goenka, Founder and CEO, IFA Global, observed that the dollar got hammered after the US April jobs data missed expectations by a huge margin on Friday.

The US headline non-farm payroll came in at 2,66,000 against expectations of 10,00,000. “The weak data print would cause the markets to align with the Fed communication of extremely gradual withdrawal of accommodation. The dollar has weakened across the board.

“...A cyber attack on oil infrastructure facilities in the US could disrupt supply and put upward pressure on crude oil prices,” Goenka said. As per his assessment, while the domestic Covid situation continues to remain grim, the global risk sentiment should support the rupee assets.

Large dollar supply

State Bank of India’s Economic Research Department (ERD), in its research report “Ecowrap”, observed that large supply of dollars will ensure that appreciation of the rupee from the current levels and this could potentially play to the advantage of the RBI in inflation management.

“The good thing is that given the prospects of higher domestic inflation, as supply disruptions mount, it is not doing any harm for the RBI to lean with the wind and let rupee appreciate as it is reducing imported inflation when metal prices are rising, and clearing the liquidity overhang to some extent,” Soumya Kanti Ghosh, Group Chief Economic Adviser, SBI, said.

Referring to the rupee gaining 154 paise between April 12 (75.0550 to the dollar) to May 7(73.5175 to the dolllar), the ERD believes that this is perhaps the result of exchange rate anchored inflation targeting that the RBI has assiduously shifted to recently. This is also evident from the recent changes in the RBI Quarterly Projection Model (QPM) model that has been calibrated to include balance of payments and exchange rate interactions as well, it added.

“So what has changed? In the merchant market (in both spot and forward segment) there was an excess supply of $86 billion during April 2020– February 2021.

“However, in the interbank market there has been excess demand of $72 billion. Overall, merchant dollar supply is far higher than demand as they anticipate a stronger rupee and hence may be holding to short position in dollars, without even adequate hedging,” Ghosh said.

This is being balanced by excess dollar demand in interbank market, but the net effect is a large supply of dollars at $14.4 billion, that has, however, reduced to $348 million in the last five months ended February 2021, he added.

Ghosh assessed that the supply of dollars in the spot market during April 2020–February 2021 by merchant segment was as much $101 billion, while in the forward merchant segment, there was an excess demand of $14.7 billion.

The interbank market, however, shows an excess demand in both the segments.

To neutralise any additional liquidity, the RBI is also intervening in the forward markets through swaps. The RBI is doing what is called a sell/buy swap, where it is selling the dollars now to buy it back at a future date and paying a premium.

“Intervention in forward market is an important aspect of maintaining financial stability, although the move has been gradual.

“Going by John Sparos (Economic Journal, 1959), the best way to fight currency speculation is to deliberately let the forward premia rise to unreasonable levels and thereby penalise the currency speculators as their exchange rate expectations about a depreciating domestic currency are belied,” Ghosh said.

Liquidity overhang

The report underscored that rising forward premia makes the carry trade lucrative and inflows keep pouring which again leads to further currency appreciation and hence more liquidity overhang.

“In the end, there could be limits to sterilised intervention and rise in forward premia beyond a threshold level. It may be noted that a high premia also deters importers from hedging their dollar positions,” opined Ghosh.