The rapid changes in the monetary policy stances of global central banks have led to the market repositioning
The spot USD / INR has been appreciating recently, touching 68.58 on Friday, March 22nd. Three broad strands of developments–domestic and global – are influencing this appreciation and the occasional volatility.
Why has the rupee appreciated?
The first factor is the rising inflows. Market chatter has pointed to rising investment flows into multiple acquisitions and even some greenfield funding, as well as inflows into the government’s Bharat ETF. Portfolio inflows have surged sharply over the past couple of months, particularly into equities. Over February and March 2019, $ 6.2 billion has come into equities, and $ 1.9 billion into bonds, a large part of this in corporate bonds. Part of the bond inflows has been allocated for the Voluntary Retention Route (VRR) scheme.
At the same time, the merchandise trade deficit in February 2019 dropped to $9.6 billion, down from an average of $16 billion in the first 10 months of FY19. Approximate estimates suggest that RBI forex reserves, net of valuation changes, have increased by over $4.2 billion in January and February 2019.
The second development is the RBI announcement of a 3 year buy/sell swap of the INR for foreign currencies. This is akin to the European Central Bank’s (ECB) Long Term Repo Operation (LTRO). Rupee forward rates have already come down significantly and by changing the hedging behaviour of importers and exporters, the swap might incentivize foreign capital inflows, with a further reduction of forex hedging costs. We await the outcome of the forward swap auction later in March to understand the implications of this instrument in guiding forex inflows.
Third, the rapid changes in monetary policy stances of many global central banks (some quite unexpected) have led to the market repositioning of global currencies, which have had an effect on EM currencies, including the INR. At its March 20, 2019 meeting, the Fed surprised markets by being even more dovish than already expected.
Earlier, the ECB had, also unexpectedly, announced the resumption of a new Targeted LTRO (TLTRO-III) scheme starting September 2019 and continuing into 2021. This was prior to the current heightened uncertainty over Brexit negotiations in the UK. The Bank of Japan (BoJ), in mid-March, signalled concerns on a slowdown of exports and industrial output, and de-rated its assessment of a slowing external economy, citing, inter alia, increased risks to global trade.
The outlook for the rupee
Going forward, again, three broad developments will influence the direction of the rupee in FY20.
The first and probably the most significant influencer will be the Balance of Payments (BoP). As of this time—quite early—we forecast net BOP inflows of $7 billion in FY20 (compared to a net expected outflow of $9 billion in full FY19). The RBI’s response in the foreign exchange market—how much it will choose to absorb to add to its forex reserves—will determine the direction of the rupee and the extent of appreciation.
The second development will be the interactions of the global currency majors. Given the current change in the stance of the US Fed and the ECB and the expected evolution of their respective economies, it is likely that the USD will recover further and remain stronger over a significant part of 2019 than earlier expected.
The third factor will be the interaction of the US dollar and Emerging Market (EM) currencies. Given the commitment of the Fed, the ECB and the BoJ to reverse the run-offs and contraction of their respective balance sheets, global liquidity is likely to remain ample. If the policy response manages the expected economic slowdown in an orderly manner in 2019, a global risk-on sentiment, which is already evident in the rise in portfolio flows to many EMs over the past month, will deepen. Investors seem to have already rated India’s growth prospects positively, and an accommodative monetary policy will support higher growth. China’s response, particularly how it manages its currency and the CFETS currency basket, will influence EM currencies. An important corollary of these policy responses will be aggregate global demand, which will, given expected supply restraints on oil output, shape crude prices (which we expect to remain stable in the $60-70 per barrel range).
The net effect of the interactions of these three broad developments will probably be higher inflows and consequent rupee strength.
Amid this, India will need to be watchful on prospects of reduced portfolio capital inflows, given the expected rebalancing of country weights in various global equity and bond indices, with China’s share expected to increase, and the coordinated policy stimulus underway in China. And, of course, the outcome of India’s forthcoming elections.
(Saugata Bhattacharya is Senior Vice President, Business and Economic Research, Axis Bank. Views are personal. Tanay Dalal contributed to this article.)