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The rupee, down 0.94 per cent, has been the second worst performing Asian currency against the US dollar so far this year. The South Korean Won (down 1.35 per cent) has lost the most against the greenback. The rupee has been under excess pressure especially in the last couple of weeks. The recent strength in the US dollar index has dragged the domestic currency below 75 last week.
The fall in the rupee accelerated after the outcome of the US Federal Reserve meeting on Wednesday last week. The US Fed will wind up its asset purchase by March. The central bank has also hinted to begin its rate hikes from March itself. Prior to this fall, the rupee had appreciated sharply all through December and in the first two weeks of January.
Strong flows earlier
Few factors helped the rupee strengthen in December. Firstly, strong dollar inflows to corporates in the form of external borrowings. Anindya Banerjee, Vice-President- Currency and Interest Rate Research Desk, Kotak Securities says, “Robust dollar inflows into corporates had overshadowed the strong outflows from the foreign portfolio investors (FPIs) in the last quarter of 2021. This helped the rupee remain resilient.” Data from the National Securities Depository Limited show that the FPIs had pulled out about $6 billion (equity plus debt) in the last three months of 2021.
Gaurang Somaiya, AVP- FX and Rates Research at Motilal Oswal Financial Services Limited, also reasons that as markets usually remain shut for some time in December due to the holiday season and trading volumes too were thin, the rupee could strengthen.
Finally, year-end dollar sales by exporters also supported the rupee.
The Fed impact
The rupee lost its momentum from the third week of January as the market began to prepare for the US Federal Reserve meeting. The currency has declined 1.2 per cent against the dollar in the last two weeks from 74.15 to 75.05.
The Fed, as expected, reiterated its stance to end the stimulus by March. The central bank also indicated that it will begin raising interest rates from March. In its December forecast, the Fed had indicated a possibility of three rate hikes in 2022. “As of now three rate hikes from the Fed is being factored in the market and the Indian markets have factored that only for the short-term. Dollar has strengthened against its major crosses on back of hawkish stance from the Fed,” says Gaurang. “Also, when the Fed begins to trim its balance sheet, which might happen after the central bank begins raising interest rates, emerging markets could see some more outflows,” he adds.
Budget expectation
The fiscal deficit number that comes out in the Union Budget can be one important factor that can impact the rupee movement. Aditi Nayar, Chief Economist, ICRA says, “Assuming that the Life Insurance Corporation’s (LIC) divestment happens next year, we project the fiscal deficit to be at 7.1 per cent of GDP in FY22 and 5.8 per cent in FY23. This will be important for both the bond yields and the rupee.”
“There is news that the government could allow a 20 per cent Foreign Direct Investment in LIC. But for this the Foreign Exchange Management (FEMA) Act will have to be amended. If that happens, it can attract strong foreign money inflows and aid the rupee strengthen,” says Anindya.
Apart from these two factors, inclusion of India in the global bond index has also been in the pipeline for some time. “If the bond inclusion happens in this quarter, it can help government borrowing. Foreign money can be attracted through that route then and it can provide support for the currency,” says Aditi.
The threats
The political uncertainty and tensions prevailing over a possible invasion of Ukraine by Russia is one of the major threats that the market is yet to price in the market according to experts. “If the Russia-Ukraine issue escalates to a greater extent, then that will seep into crude oil prices. If the crude prices surge to $100 on the back of this, then it could be a big threat for the rupee” says Anindya. “The outcome of the Reserve Bank of India’s policy meeting next month is important. If the RBI decides to be aggressive as the Fed, then we could witness some heightened volatility in the currency and debt market” ends Gaurang.
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