Shishir Asthana
Moneycontrol Research
Currency traders were waiting for the rupee to touch the 70 mark against the dollar. However, UP election results caught them on the wrong foot. Positive sentiment on account of an overwhelming victory in Uttar Pradesh saw a sharp jump in foreign institutional investors (FII) inflows. FIIs pumped in over Rs 4,000 crore on Tuesday, the first day of trading post elections results.
As a result the Indian rupee hit a 16-month peak of 65.41 against the dollar on hopes of continued flows. This level was last seen in November 2015. At the current level rupee is the third best performing Asian currency after South Korean Won and Taiwanese dollar since the start of the calendar year.
However, there are other factors that have also decided the trend of the rupee. Falling oil prices have silently supported rupee strength. Oil prices have fallen to USD 48 per barrel and are at their three-months low. Rising inventory levels in the US on account of a surge in shale oil has resulted in oil prices slipping despite a cartel being in place by OPEC.
The more important point for the market is where the rupee is headed going forward. A stronger rupee is good for foreign investors, which, in turn, is good for markets.
The strength of the rupee can be judged from the fact that China with its trade surplus has seen its currency depreciate while at the same time India which runs a marginal trade deficit is having a stronger currency. Despite the opposite movement of both the currency, Chinese Yen is still costlier than the Indian rupee measured strictly on real effective exchange rate (REER) index. Directionally, both Indian rupee and Chinese Yen REER is ascending, suggesting overvaluation.
However, one of the main reasons for overvaluation of both the currencies is flight of capital from emerging markets post a Donald Trump victory in the US. This has been reversed in India in both equity and debt markets.
After a steady withdrawal of debt from India on account of maturity of FCNR (B) (Foreign Currency Non-Repatriable) account and reducing arbitrage opportunity due to reducing interest rates in India and US, investments have started trickling back in. US interest rate hike is already discounted by the market which is borne out by the fact that volatility has reduced over the last few months.
Economic fundamentals are expected to improve with the hope that the government will step on the gas after a resounding victory in UP. A stronger economy will attract more funds in India.
Oil prices, crucial for India’s trade deficit, are likely to remain low. The OPEC cartel, though, has stuck to its production cuts and it has been unable to take prices higher. Production activity in the US for shale gas is moving at a breakneck speed. Companies are reportedly facing problems finding drivers in the US on account of the fast pace of growth. Further, oil inventory levels in the US have been rising for nine weeks running.
A strong rupee is bad for export-oriented companies, but over the last few years exports have not actually contributed to India’s growth story. A status quo in exports is unlikely to dampen market spirit, especially since sectors like IT and pharma that are largely dependent on exports are out of favour.
In conclusion the rupee might continue in strength for some more time with the underlying fundamentals which will have a bearing on the rupee and decide its future course.
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