India: Unsupportive global backdrop weighs
Double whammy of high US rates and rebound in crude prices set an unfavourable backdrop for the rupee at the start of the week, as a fall to a fresh low below 82.70 ran into official resistance, leading the USDINR to close around 82.30 on Monday. Risk appetite is likely to be under the pump today as well as Russia-Ukraine tensions rise anew. Foreign reserves are down by ~$5bn in the latest update to a two-year low of $533bn, but the import cover is supportive at ~8x, higher than 6x during the taper tantrum in 2013. Reserves are also well-cushioned at 2x of short-term external debt, by residual maturity, the other closely watched barometer. Notwithstanding this fall, the rupee is in middle of the AXJ FX pack, faring than its regional peers, still slightly overvalued on real effective exchange rate basis and stronger than ex-USD currencies (EUR, GBP, JPY etc.).
In recent remarks, the central bank had put two-thirds of the fall in reserves to valuation effects (i.e., stronger dollar). While questions arise on steps to boost reserves, the latter is primarily a function of the current account balance as well as strength in financial flows, which outside of the relatively resilient FDI, face challenges from heightened volatility, sticky oil/ coal imports and growth uncertainties, in effect slowing net accretion. The FCNR deposits route tapped in 2013 might not be as effective this time around for reasons including, much narrower US-India rate spreads and less aggressive rate hikes by the RBI, in this cycle vs 2013. Even as the current reserves stock provides sufficient cushion against volatility, the notable year-to-date drawdown is likely to see the authorities stay opportunistic and deliberate in their intervention attempts to ensure efforts yield adequate bang for the buck. This implies that a shift due to a wave of broad dollar strength /and global volatility is likely to see the currency adjust down along with the regional peers, while the pace and incline are reined in through intervention.
As our Strategists opine in recent commentaries, INR 10Y yields have continued to drift north, rising to 7.5% yesterday, as a delay in the bond index inclusion plans, and buoyant global rates (and soft rupee) put a floor under rates, notwithstanding better cut-offs at Friday’s bond auction. The yield curve maintained a flattening bias with the short end/ 5Y yields up on seasonal liquidity tightness and hawkish policy bias. Domestic benchmark equity indices are off highs, but still viewed as an attractive bet in the region, inferring from a return in foreign portfolio inflows in Oct and the index’s relative YTD outperformance on local currency as well as USD terms compared to peers.
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