Tug-of-war on the Indian Rupee in the time of Corona Virus

Rupee rate

After hovering between Rs 71-72 to the USD for half a year, or more precisely between August 2019 and February 2020, the Rupee has rapidly plummeted to 76 per USD in early April 2020.

This nose-dive has occurred despite the fact that oil prices are at an all-time low. However, while the CAD has been pulling the rupee value upwards, there have been various other heavy-weights that have been dragging the Rupee down.

Here we take a look at 6 major factors that have been impacting the Rupee one way or another and conclude with our technical outlook, which declares who the winner of this tug-of-war is likely to be.

Major factors currently affecting the Rupee

  1. FII fund outflows from Indian Equity& Debt markets
  2. Fall in interest rate
  3. Dollar Index appreciating
  4. India’s REER
  5. Fall in Forex Reserves
  6. Fall in Crude Price may improve India’s Current Account deficit (CAD)

Let’s look at the impact of each of these…

1.FII fund outflows from Indian Equity & Debt markets

More than Rs 1 lakh core worth of Foreign Institution Investors (FII)money was taken out of the Indian equity and debt markets in March 2020, making it the highest-ever sell-off by FIIs in any single month. FIIs sold equities worth Rs 61,673 crore and another Rs 60,376 crores of debt instruments in March.

Foreign Investors withdrew money from equity markets mainly due to the typical asset risk consideration on the back of the fast spread of Covid-19 across geographies. The 21-day nationwide lockdown in India added to the concerns of economic disruption.

The panic sell-off by FIIs in domestic markets, dragged the benchmark Nifty down by more than 23% in March.

Needless to say, this colossal exodus of funds impacted the Rupee value adversely and any further FII outflow from the Indian markets in the coming months would drag the Rupee down further.

2. Fall in interest rates put pressure on the Rupee

High and rising interest rates are usually correlated w-ith a stronger Rupee and falling or low interest rate, with a weaker Rupee.

Recently, the Reserve Bank of India’s Monetary Policy Committee (MPC) announced a reduction in the policy repo rate by an unprecedented 75 basis points. It also undertook other measures to make available ample liquidity to tide over the huge challenges that arise in the wake of the COVID-19 pandemic.

Further, on March 18, the RBI has announced that it would be injecting liquidity into the markets through the purchase of short-term notes and government bonds to ease bond yields, which have spiked due to risk aversion. However, monetary easing will pressure the rupee downwards.

 

3. Dollar Index strengthens

The Dollar Index is a major determinant for the strength of the Rupee. Any appreciation or deprecation of this index may impact the USD/INR exchange rate. The strength of the Rupee is usually negatively correlated with the rise and fall of the Dollar Index.

Over the past three months, the Dollar Index appreciated by 3.6% and during the same period, the Rupee depreciated against the Dollar by 6.0%.

4. India’s REER slightly overvalued

According to a recent report by Fitch Ratings, the Rupee’s Real Effective Exchange Rate (REER) Index is trading 5.2% above its 10-year average, which suggests that the currency is mildly overvalued. According to the latest RBI data too, the rupee’s REER against a basket of 36 currencies, in terms of trade-based weights, was 119.47 in February. Going forward, based on the REER value, we can expect the Rupee to correct 5% to 6% approximately from here.

 5. Fall in India Forex Reserves as RBI might have taken effective measure to arrest the Rupee fall

According to a recent RBI report, India’s foreign exchange reserves fell by $11.98 billion. Currently, total reserves stand at USD 469.9 billion (20 Mar 2020), down from USD 481.90 billion (13 Mar 2020), marking the biggest weekly fall in forex reserve since 2008.

The RBI might have continued to supply dollars into the market to arrest the fall in the Rupee value but any further fall in forex reserves would put pressure on the Rupee.

At the same time, India’s gold reserves decreased by USD 1.61 billion during the same week (13th to 20th March 2020), i.e., dropping to USD 27.9 billion from USD 29.5 billion in the previous week.

6.Fall in Crude Price may improve India’s Current Account deficit (CAD)

US crude and international benchmark Brent prices plunged to multi-year lows (18 year low) mainly due to the Corona virus outbreak, which erased the demand for crude oil. Over the past three months, WTI crude oil fell 67.5% from USD 61.47/barrel to USD 20/barrel.

Also, OPEC failed to strike a deal on production cuts with its allies, including Russia. That led Saudi Arabia, the world’s largest oil exporter and the de facto leader of the energy cartel, to slash oil prices and threaten to ramp up production.

India is the second largest importer of crude oil in Asia, after China. India imports more than 80% of its crude oil requirements; a significant price change in crude oil has a direct effect on India’s current account deficit (CAD). Falling crude oil prices could reduce India’s inflation and lower the cost of its import bills. That could, in turn, help narrow the country’s trade and current account deficits as every dollar per barrel drop in crude prices reduces India’s import bill by Rs 10,700 crore approximately, on an annualized basis.

The significant drop in crude oil prices coupled with the government’s recent hiked in excise duty on petrol by Rs  6/litre (from Rs 2 to Rs 8 ) and Diesel by  Rs 3/litre, could help limit the extent of rupee depreciation, even in the face of the adverse impact of all the other factors listed above.

Rupee Technical Outlook:

Technically, the Rupee looks very weak. It has broken the key resistance level of 74.50 on 19th March 2020.We expect the USD/INR pair to face strong resistance at 76.50 levels. Once it breaks above this level, the price can head towards 78 levels first and then march towards 80++ over the next six months to one-year period.

You May Also Like to Read: What’s driving gold prices down in a time of crises?

 

Disclaimer:

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

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