Historically, a ‘sell and run away’ month

The rupee and Reserve Bank of India (RBI) have amazed hedgers and speculators worldwide, with a robust performance despite the moves in the dollar, global geopolitical risks, demonetisation, etc. Long-term hedgers, especially exporters on the sell side, have tremendously benefited due to premiums and currency appreciation.

On the current account front, the April trade deficit widened to a 29-month high (of $13.25 billion), despite strong growth in exports on a year-onyear basis. Crude oil prices are likely to remain relatively stable. Demand for gold is likely to remain muted as jewellers clear stocks built in anticipation of the marriage and festive season; a rise in political risks in the US has been a dampener.

On the capital account front, inflow has continued into primary and secondary markets. Though inflow into the equity market was showing signs of slowing, yieldseeking foreign investors have continued to pour money into debt. Now, with consumer price index (CPI) inflation likely to significantly undershoot the central bank’s comfort zone, the Monetary Policy Committee might tone down its hawkish stance. This could further lure investors from abroad to the debt markets, on account of high real rates. India currently offers one of the highest returns in real terms among emerging markets, reflected in the rupee’s performance.

Recent US data, meanwhile, are below expectations (CPI and retail sales), which could imply that the Federal Reserve would hike rates and roll back its balance sheet size in a calibrated manner. In India, upside risks to inflation stem from a below-average monsoon, hike in the housing rent allowance component of the pay commission and rollout of the goods and services tax. With equity markets doing well, a number of primary market issuances are in the pipeline. The government is also looking to reduce its stake in public sector units. Rupee-denominated bonds (masala bonds) are gaining in popularity.

All this implies that inflows into capital markets could continue in the medium term. Foreign portfolio investors are invested to the extent of 82 per cent of the permissible limit in central government securities and 84 per cent in corporate debt. This implies that ~112,000 crore ($17 billion) of limit is available for further investment in the debt markets.

Looking at the bigger picture, as long as the monthly trade deficit of $11-13 billion is funded by inflow into equity and debt ($2-4 billion), net foreign direct investment ($23 billion) and net inward remittances ($6-7 billion), one can expect the rupee to be reasonably stable, with an appreciating bias.

The extent to which the central bank absorbs the inflow into capital markets will significantly affect the rupee’s performance. It might continue to intervene in spot and pay forward. This can continue to support the forwards, especially far-forwards. RBI’s forex reserves as on May 5 was $375.7 billion, in comparison to $364 billion as on March 3. Recent price action gives the impression that the central bank has been protecting the 64-handle; therefore, 63.9 would be a crucial short-term support. On the upside, a break and close above 64.72 is required for a medium-term reversal. The rally in the rupee to a large extent has been liquidityfuelled. A reversal could be equally sudden and strong, when the liquidity tide reverses or on risk aversion. The recent Trump drama and weakness in global markets could become a game changer and an important indicator to watch for. After all, it’s May and historically they say, ‘Sell and run away’.