Dollar demand could weigh on the rupee

BL Research Bureau

The rupee has marginally declined since the RBI's monetary policy announcement, last week. Though it briefly appreciated above 71, the rupee could not extend its gain beyond those levels. On Wednesday, the Indian currency opened lower at 71.18 against its previous close of 71.02 and continued to remain within the key levels of 71 and 71.4. Interestingly, the rupee is the weakest currency in Asia month-to-date.

Looking at the year-to-date performance, the domestic currency has weakened by 2 per cent against the dollar and by 4.4 per cent against the Japanese Yen. But it fared better against other majors as it gained by 2.5 per cent versus the Euro and 2.4 per cent against the British Pound.

The offshore market did not witness much volatility; one-year at-the-money volatility only pipped up to 6.8 from 6.65 over the past week. One-year Non-Deliverable Forward (NDF) contract’s premium is at 325 basis points. It has been fluctuating between 320 and 340 basis points since the beginning of the month.

RBI monetary policy

Last Friday, the RBI announced a repo rate reduction of 25 basis points. The central bank also sharply reduced the GDP growth expectations for the current fiscal to 6.1 per cent from earlier projection of 6.9 per cent, stating further that the domestic demand conditions continue to be weak. These factors triggered a sell-off in the Indian equity market, which was already disappointed, as it was expecting a deeper rate cut.

Since the beginning of October, the Foreign Portfolio Investors (FPI) has been net sellers in both equity, and commodity segment. They dumped ₹3,825 crore worth of equity and they net sold ₹205 crore worth of debt, totalling to net investments of negative ₹4,020 crore for the current month up to October 8.

However, the RBI indicating the possibility of more rate cuts, thanks to a sanguine inflation outlook, lent some comfort. The RBI also maintained its accommodative stance. However, the central bank expected the crude oil prices to be volatile in the near-term and pose some risk for the Indian currency given the import dependency.

Geopolitical risks

There was an uptick in geopolitical tensions as the US imposed visa restrictions on Chinese officials and blacklisted 28 Chinese entities, citing abuses on Muslims. Such a development before the trade talks between the US and China has dimmed hope of progress among investors.

Unease in Turkey-Syria border and unending protests in Hong Kong continue to favour the dollar, weighing on emerging market currencies.

Technical outlook

The US dollar index, measurement of the dollar against a basket of six major currencies, continue to trade within 98 and 99. Technically, the index is trading in a range, and the next leg of the trend will occur only if the index moves out of it. On the upside, the index has resistance at 100, a major psychological level. Below the range, the dollar index will find support at 97.2.

The rupee too is currently trading in a range between 71 and 71.4. The domestic currency will most likely stay within the range for some time unless dollar demand surges on the back of geopolitical developments. Above 71, the rupee can appreciate to 70.5 whereas it could depreciate to 72 levels if it breaks below 71.4 against the dollar.