Rupee value will stay value appropriate to most stakeholders

Rupee has traded within the comfort zone of 66-69 in first-half of 2016; it can be also termed as tolerance zone, as overshoot either-way is seen as excessive that could trigger panic among most stakeholders, either on hedged positions or on uncovered portfolio. The moves so far have been back-and-forth within 66-69 with bouts of sudden and extreme volatility; 4-5 percent swing within a short period is high-risk and squeeze in business & revenue margin if on the wrong side. The good thing is that it is not painful for long term players given the rate of rupee depreciation not significantly beyond the end-to-end interest rate differential (between January-June 2016), while it has turned cost inefficient for short term carry-trade entities and speculative overseas investors. Bottom-line, rupee volatility has helped to reduce speculative short term flows while encouraging long term stable flows, both on trade and investments. The outlook for H1/2016 has been for rupee volatility staying restricted at 65.85/66.20-68.50/68.85 with hedge strategy of hedging short term foreign currency liabilities while 3M forward rate trades below 67.50 and covering long term foreign currency assets while 12M forward rate moves above 73. In short, spot USD/INR value around 66 was seen cheap to acquire, and value above 68.50 was seen excessive and hot to hold.RBI was also seen administering this range to keep rupee value between staying attractive to exporters/investors and not turning resistive to accommodative monetary policy. All combined, rupee moves in the first-half of 2016 is seen in order with depreciation of annualized 6 percent (from 66 to 68), which is in exact reflection of the interest rate differential between India and the United States.

What next in H2/2016? The macroeconomic fundamentals continue to stay in favor of India, from both within and outside. The domestic cues across growth and fiscal deficit is in above-par standards, with bias towards turning better against high confidence of worst is already way behind.There are no major downside risk from current account deficit and inflation. The pipeline policy initiatives around GST roll-out, capacity expansion, cost optimization, revenue maximization, attracting foreign investments, revival of domestic investments and higher public investments in core sectors are all positive signs to turn catalyst to spur GDP growth momentum over 8 percent and squeeze fiscal deficit to 3 percent. The serious concerns on current account deficit and balance of payment since the early 1990s are well behind now. The cycle has turned to manage surplus foreign currency liquidity to the extent that short term, hot money flows are no more wanted now. The management of rupee depreciation in alignment with interest rate differential and tightening the agreement with free trade zones are case in point to discourage such flows. While inflation risk is not yet behind with CPI at striking distance of higher end of 4-6 percent tolerance zone, there are no panic signals given the comfort from stable commodity prices, good monsoon and measures of the government to remove supply-side bottlenecks. All combined, the domestic cues are good and relatively more attractive compared to developed economies and emerging markets to keep external appetite on India assets intact. The long term foreign investors will continue to stay on hold, and in accumulation mode absorbing sharp value-erosion on risk-on assets. While all the above-said factors stay in support of rupee over long term, short term volatility from external cues cannot be wished away. However, the downside risk on rupee in H1/2016 from sharp USD appreciation in traction with Fed rate hikes is now not relevant. The evolving dynamics in developing economies do not support Fed rate hike in H2/2016. India retains its position as one of the few attractive destinations to benefit from ultra-dovish monetary policies of the developed world. All combined, while it is comfort for long term stay-put entities, it is also risk-neutral for short term hot-money players.

All taken across domestic cues and external dynamics, rupee range for H2/2016 is set at 67-70 against H1/2016 outlook at 66-69, with marginal time-decay value adjustment. Given the end of 2016 spot target not beyond 70, the hedging strategy is more or less similar to that of H1/2016. It is good for importers to stay risk-off in the shorter end liabilities while 3M forward rate trades below 68.50 (spot at 67-67.20), while it is risk-neutral for exporters to cover long term foreign currency receivables while 12M trades at 72.50-73 (spot over 68.50) retaining appetite for 73.50-74 on unforeseen event-led spot rupee weakness into 69.50-70. Having said these, the road ahead is not clear with emergence of unexpected event risks to be disruptive on markets. It is not advisable to be on the extremes of risk appetite, it is good to stay close to the risk-neutral mode to avoid losses that cannot be absorbed by the balance sheet. For rest of 2016, it is good to stay prudent to protect the bottom-line rather than be greedy for more!