Rupee to stay in range on RBI intervention

In recent weeks, currencies have pied-piped to the tune of long-term interest-rates, rising on the hopes of removal of monetary accommodation. Shifting tides toward policy normalisation in North America, Australia, Europe (on economic recovery) and in the UK (out of an inflation surge due to currency weakness) have helped both the euro, CAD, AUD and Sterling pound gain to multi-month highs. The yen gained only moderately, due to its continuing soft monetary policy, while the US dollar was an all-round loser due to a number of reasons. In the US, ineffective legislative action (inability to pass proposed health care/budget legislation), political inertia and external priorities (Nafta re-negotiation), no wage growth, little inflation and an expected slow pace of policy tightening has caused a steady unwind of the “Trump trade”.

This month only Bank of Canada has joined US Federal Reserve in policy tightening while the European Central Bank (ECB) and Bank of Japan (BoJ) have both conveyed steady messages. The latter two seem to be taking tentative steps to avoid triggering currency strength, tightening financial conditions and risk of jeopardising the nascent recovery. Pound’s weakness after the soft June 2017 CPI (+2.6%pa y/y) clearly demonstrates the sensitivity of currencies to monetary policy anticipation.

The rupee has benefited substantially from the global dollar weakness with buoyant capital flows overwhelming a narrowing trade deficit (U$ 12.96 billion down 6.08% y/y). The stable political environment, continuing structural reforms, stable fiscal position and benign inflation have caused rallies in domestic asset markets.

Expectations of a looming Reserve Bank of India (RBI) rate cut caused government bond yields to soften to multi-month lows while stock indices surged to all-time highs. But with export growth tepid (+4.4% y/y in June 2017), out of rupee over-valuation (10% plus), policy makers have restrained further rupee strength by covert intervention.

This has partly incremented FX reserves to all-time highs (+U$16.43 billion in FY2018 to U$386.38 billion). However, to manage the incremental rupee liquidity, RBI has conducted sell/buy swaps and pushed spot dollar purchases (and resultant rupee inflow) to a future maturity as also initiated OMOs for up to Rs 20,000 crore. So, the rupee has ground to an ever tightening range of 64.90-65.08 /US dollar on top and intervention-created lows in the 64.15-63.92 /U$ area.

We expect these boundaries to hold in the coming weeks while awaiting the seasonal dollar demand to manifest.

The writer is chief operating officer, Kotak Mahindra Bank