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| Edited By: Ananth Narayan |Source: DNA |Updated: Mar 22, 2018, 03:34 AM IST
Over the past five weeks, this column has urged hedging of foreign currency exposures. The arguments were simple. Notwithstanding positive flows, the world looks uncertain, the rupee is overvalued in real effective exchange rate (Reer) terms, and there is an overhang of unhedged exposures in India. Given the events of the past two weeks, and despite the 2.3% move up in USDINR since, this recommendation stands.
US election results have moved global markets. The narrative is of Trumponomics expanding US growth with tax breaks, fiscal spend, and US corporates bringing back and deploying their cash surpluses. US inflation expectations have shifted up, and 10-year treasury yields are up 60 basis points to 2.35%. In turn, global yields have risen, and the US dollar has strengthened substantially. USDCNY is now approaching the psychological level of 7.00, USDJPY has moved beyond 110, and EURUSD is below 1.06. Emerging markets have been rattled, prompting central bank intervention in some cases.
Despite these market moves, this scenario is still somewhat benign, given the underpinning of a growing, strong US, that could eventually support global growth and trade.
There are alternative – less benign - narratives that could play out over the medium term. The big risk is of protectionism, with walls and barriers restricting global trade. Europe will face a series of existential political questions now – with the Italian referendum, French and other elections scheduled over the next few months. Shrinking global trade could impact China, which is already nursing bank credit at 2.5 times its GDP. All this could spiral into global risk-off, test exhausted central banks further, and risk geopolitical turmoil.
Both narratives could imply a stronger USD – either via risk-on or risk-off.
In the near term, there are events to watch out for. The next two weeks will see the last, chunky FCNR repayments going through. USDINR forward premiums, already sharply lower the last few weeks, could dip even further, with possibility of temporary USD shortage. As USDCNY approaches 7.00, do watch for Chinese and other central bank actions and pronouncements. Trump's cabinet announcements will offer clues on the world ahead.
The Indian economy, standalone, remains in a relative medium term sweet spot. However, if there is anything that 2016 has taught us, it is that we simply cannot predict the future. Given global uncertainty and risk premiums, given that INR is 17% overvalued in Reer terms, given there is complacency, insurance against unhedged exposures is warranted.
The writers is regional head of financial markets, ASEAN & South Asia of Standard Chartered
