Wondering what is behind the rupee's recent rally? Here's a lowdown

Q1) Why did the rupee rally after the RBI policy on Wednesday when the bond and equity markets remained relatively unaffected?

The domestic bond and equity markets remained largely unaffected by the RBI’s decision to cut repo rate by 25 bps to 6 percent because it was along expected lines. Dealers said that the rate cut had already been factored into both these markets before the announcement was made.

Also, the RBI said that inflation was likely to rise in the second half of the current financial year, which curtailed expectations of further rate cuts this year. This, and the fact that there was no other major action announced by the central bank, left market participants with nothing to cheer.

However, the rate cut led to foreign investors buying into Indian bonds even as domestic investors dumped them. The increased foreign inflow resulted in the rupee gaining past the 64 mark against the dollar. According to dealers, 64 was a major psychological support level and when it was breached, there was some panic-selling of dollars, which pushed the rupee’s value higher.

Q2) Why has the rupee risen by over 6 percent since the beginning of the calendar year?

The rise in the rupee’s value this year can be majorly attributed to the increased inflow from foreign portfolio investors (FPIs) into both equity and debt markets. FPIs have net bought USD 17.7 billion and USD 8.8 billion in the domestic debt and equity markets, respectively, so far this year.

When foreign investors want to buy into Indian markets, they need to sell dollars and buy rupees in order to do so. This increases demand for the rupee, thereby pushing its price up.

Also, the dollar has been trading weakly since the beginning of the year, with the dollar index having declined by over 9 percent till date. A weak dollar indicates that investors are more interested in other markets, particularly emerging ones.

Q3) Why has the dollar index fallen so dramatically since January?

Investors looking to buy into emerging markets have sold the dollar quite heavily over the last few months, resulting in a decline of the dollar index, which measures the strength of the greenback against six peers.

The dollar has depreciated by as much as 13 percent against the euro this year. Against other major currencies like the yen, pound and renminbi, it has depreciated 3-7 percent.

According to market experts, the fall started as a reversal of the gains made immediately after Donald Trump was appointed President of the United States. The fall gathered momentum as investors grew sceptical about whether or not Trump will be able to deliver on his promises.

The US Federal Reserve’s weak outlook on inflation and its resultant decision to not hike interest rates at its recently concluded meeting have also weakened the outlook for the dollar.

Q4) Why are foreign portfolio investors buying Indian securities so heavily?

When the RBI changed its stance on liquidity to "neutral" at its February policy meeting, bond yields rose by around 40 basis points in the following couple of months. This made Indian debt really attractive to foreign investors, who bought into them heavily for the higher yield.

In addition, India’s real interest rate, which also takes inflation into account, is one of the highest in the world and certainly the highest in Asia.