Dollar weakness, FX reserve bulge will help rupee to gain

2018 commenced with risk aversion overturning most global asset market trends of 2017. In late January, the US dollar rebounded from a three year low on expectations of faster Fed tightening, confirmed in FOMC minutes, due to, positive implications on growth, after the bipartisan budget agreement and on negative ones on rising inflation due to firming wage growth. Global stock markets shuddered, oil prices softened and volatility surged.

The US Congress passed another continuing resolution to suspend the debt ceiling till March 23. President Donald Trump proposed a $4.4 trillion federal budget for 2019 contacting Medicare spending over military and immigration enforcement. He also proposed a “reciprocal import tax” and reiterated his $1.5trillion infrastructure plan. The budget deficit will now almost double in FY19 to $984 billion and raise $7.1 trillion over the next decade, triggering negative commentary from rating agencies. Stubbornly, elevated January CPI and manufacturing PMI confirmed the hawkish narrative pushing the US 10-year treasury yields to 2.957%, a four high but could not help the US dollar.

The Euro round-tripped from $1.2536 to $1.2204, after news of a coalition in Germany between the CDU/CSU and SPD and softer PMIs, ahead of Italian General election on March 4. The pound also shrank sympathetically from $1.4344 to $1.3763 on continuing negative Brexit rhetoric. But it rebounded past $1.41, after a hawkish hold by the Bank of Equalization (BoE). Discordant views among MPC members about merits of a weak pound brought it back to $1.3850. The Yen gained toward 106.00/$ on safe-haven demand countering higher US yields plus the Bank of Japan's (BoJ) re-emphasis on ultra-easy policy.

The rupee peaked at 63.45 (January 25) after the Economic Survey indicated that the Reer-based appreciation had made India’s exports less competitive. It weakened to 64.44 after the Union Budget‘s challenging fiscal position and imposition of long-term capital gains (LTCG) tax caused stock and bond markets to slump. The central bank's MPC kept a neutral stance and the repo rate unchanged at 6% with a 5-1 majority. The dissenter, Dr Michael Patra, favoured a 25bp rate hike. It maintained a cautious outlook on inflation and appeared vigilant on the nascent cyclical growth recovery with the forward guidance less hawkish than expected. Retail/wholesale inflation and industrial production all moderated from their peaks while remaining elevated, increasing hopes that both the demonetization and GST-related disruption have run their course. But, the January trade deficit shot up to $16.3 billion, highest since May 2013, as export growth slowed (+9.1%) and imports rose (+26%). Exporters pointed to the imposition of GST and delays in input tax credits as the prime reasons.

Global dollar weakness helped the rupee gain to 63.80/$ while India’s FX reserves swelled to an all-time high of $421.91 billion. But, a $ 1.8 billion foreign trade-credit related, banking fraud in a PSU-bank caused the rupee to weaken dramatically to 65.10/$. Till March-end, the rupee is expected to trade the 64.30-65.50 range.

The writer is president and chief operating officer, Kotak Mahindra Bank