After the record drop, RBI may keep rupee on leash

As expected, the last week saw small signs of temporary, frictional USD shortage in the foreign exchange market (Fx), even as the last of the foreign currency non residential (FCNR) repayments are ongoing. Thus, in the early and middle part of the past week, USD/INR forward premium came off sharply. USD/INR tested record lows at 68.82, before suspected strong RBI intervention cooled the spot and forward markets.

For the past six weeks, this column has strongly urged for hedging of foreign currency exposures. While the core recommendation will remain, there is reason to believe there could be some short-term relief in the Fx markets.

Domestically, the authorities will be mindful that the move so far has been rather sharp. Given ongoing domestic events of the last of the FCNR repayments, and demonetization, the authorities may be keen that the short-term financial stability should not be brought to question. With ample reserves and still stable macroeconomic undercurrents, the authorities have significant ammunition to control market volatility.

Globally as well, perhaps there is room for some relative stability, after a very hectic past three weeks. USD/CNY is nearing the psychological level of 7.00, and the USD index has already risen by 5% since the US election results. Any breather in the international markets will in turn allow for some correction in Indian forex markets as well.

However, the medium-term uncertainty has not yet gone away. The world is still unsure on what the future portends – Trumponomics of higher US consumption, investments, and fiscal spending, or increased inward looking politics around the globe leading to lower trade and global growth. Both these could imply eventual USD strength, through very different implications for the global economy and emerging markets. There is also no shortage of potential market-moving events on the horizon – such as prolonged Organisation of Petroleum Exporting Countries (Opec) discussions, the US Federal Market Operations Committee (FOMC) meetings, among other upcoming political events.

The Indian medium to long-term economic context remains relatively positive through all this. However, given global uncertainty, given rupee is over 16% overvalued in Real Effective Exchange Rate (Reer) terms and the overhang of unhedged exposures, it would still be prudent to use any corrections to buy insurance in the Fx markets.

The writer is regional head of financial markets, Asean & South Asia at Standard Chartered