The Indian rupee has fallen to record lows in the last two sessions, before closing shy of a fresh low of 79.0/ dollar in overnight trade. Maturing forward contracts are suspected to have weighed on the INR this week, besides an unsupportive market backdrop of portfolio outflows (June -$6.3bn), high oil and bid dollar. Authorities stepped up intervention in in the spot and futures markets, which helped to slow the pace of decline, but not reverse the trend. Even as the rupee emerged as a regional underperformer this week (vs Fri’s close), the 5.8% year-to-date depreciation still leaves it around the middle of the Asia ex-Japan pack. As noted earlier, the central bank’s active intervention in the forwards market, in a bid to be liquidity neutral and preserve foreign reserves, has created ripples elsewhere, including pushing forward premiums sharply lower (1Y fell below 3%). Besides intervention, narrowing rate differentials as well as perceived dollar shortage has accentuated this fall. A scenario where lower premiums incentivise importers to aggressively cover their unhedged exposures and exporters have less motivation to step in to cover theirs, tends to add to USDINR upside. Beyond the near-term price action, with the US dollar lifted by a hawkish Federal Reserve and impending domestic balance of payment deficit, the evolving equilibrium will be to keep the currency on a gradually depreciating path as an adjustment mechanism. Our FX Strategist does not dismiss more weakness if USD/INR breaks above 79 but sees 80 as elusive if the USD reverses trend on US recession worries in 2H22.
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