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| Edited By: Ritesh Bhansali |Source: DNA |Updated: Oct 29, 2018, 05:45 AM IST
The rising US bond yields have caused huge volatility and ripples across global financial markets leading to outflows from equity and debt markets in the emerging markets. The US 10-year yields rose to a seven-year high of 3.26% and currently trading at 3.14%. The effects were clear, which led to a free fall in emerging market currencies most notably in countries with twin deficits like India. To make things more difficult, estimates suggest that CAD is expected to widen to $75 billion from $48.7 in 17-18 equating to increase from 1.9% of GDP to 2.8% of GDP. So far this year, the foreign institutional investors (FII) have withdrawn Rs 28,838 crore and Rs 61,756 crore from equity and debt markets respectively.
The hawkish comments from the Fed, aggressive rate hikes and positive economic data from the US has ensured a strong dollar this year. IMF has also downgraded world economic growth to 3.7% of GDP owing to rising trade protectionism, gradual withdrawal of stimulus and tight liquidity conditions. A glimpse of this can be seen in the crashing US and global equities. Brexit jitters in the market and Italy's 2.3 trillion euro public debt makes the country vulnerable and a potential source of contagion for other eurozone countries, dampening the investor's mood making them flee to safe havens like Gold, Yen, Swiss Franc and US dollar to an extent.
In the current year, dollar-rupee has closely tracked crude oil prices. Crude oil has appreciated by 19.5% whereas rupee has depreciated by 15% YTD. The US sanctions due on November 4 are expected to reduce oil exports from Iran and had boosted oil prices by as much as 25% earlier, but on the back of the recent pledge by Saudi Arabia to meet the supply crunch by increasing its output has pulled oil prices back to a two-month low at 76.5 $/b. Although, crude oil has fallen by 14% from its recent high of $86.5 per barrel rupee has appreciated by only 2% from its recent low of 74.57. This reflects limited upside potential in the rupee.
The Indian government has tried to stop the free fall in the rupee by making it easier for foreign investors to buy rupee bonds issued by Indian companies. The government also raised tariffs on imported goods to reduce the outflow of money, easing ECB regulations for manufacturing and oil marketing companies. Such measures have not had a material impact but at least this has reflected clear intentions from the Reserve Bank of India (RBI) and government to stabilise the rupee with more measures on the anvil if conditions deteriorate further. Two measures which can have a strong positive bearing can be the introduction of oil swap window or NRI bond issue. One can expect such measures if the rupee depreciates further towards 75-76 levels in a short span of time.
In view of Indian context, most negatives such as rising oil prices, liquidity issues in NBFC sector, delay in NPA resolution, political uncertainty due to upcoming state elections, stretched equity valuations are already priced in the current scenario leading to a correction in the Indian equity markets along with a weakening rupee. On the contrary, recent correction in the US equity markets may prove to be a blessing in disguise as foreign investors may start withdrawing money from the US equity markets and investing in emerging markets with sound fundamentals.
On REER basis, the rupee has weakened by 9.8% and 5.6% on CYTD and FYTD basis. Most of the REER adjustment is on account of NEER as inflation differentials have remained broadly stable. With RBI offloading FX reserves of $32 billion from its recent peak, rupee strength will be limited as RBI will try to prop up FX reserves with every correction in dollar-rupee, which will also level for importers to seize an opportunity.
We expect the rupee to stay range bound between 72-74.5 levels. The dollar-rupee can resume its uptrend on a breach of 74.10 levels which looks less probable at the moment. On the downside, a breach of 72.80 will be crucial for a move towards 72.00.
The writer is AVP-forex risk consulting, Mecklai Financial
