“The RBI could intervene intermittently as the rise in oil prices, a US dollar very likely to weigh on the rupee”
The abruptness and uncertainty surrounding the impact of the pandemic prompted a coordinated, multi-pronged aggressive monetary policy response around the world. Given that most economies were comfortable with inflation before the pandemic, such aggressive actions appeared to be the most effective and adequate in dealing with the shock of Covid.
However, as deliberations on the post-Covid policy framework approach, central banks around the world will face several challenges in the times to come, as compromises can be extremely difficult. As the mandates of most central banks have been diluted towards dual or multiple goals, the credibility of their ability to stabilize inflation in an environment where interest rates are near their all-time low remains in doubt. question.
In addition, the unprecedented expansion of central banks’ balance sheets and their limited ability to unwind suddenly to avoid further distortions in financial markets could keep the prices of risky assets high, creating room for bubbles sooner rather than later. .
However, for now, in the short term, markets will focus largely on the growth and inflation differentials between DMs to assess the duration of accommodative monetary policies. Generally speaking, we would expect the DXY index to have a strengthening bias in the near term, although this largely depends on the extent of the Fed’s cut and the expected growth outcomes and inflation in the G3 over the medium term. In addition, we must take into account the political constraints of the euro area in terms of extending the Emergency Pandemic Purchasing Program (PEPP) beyond its scheduled expiration in March 2022. This could reduce purchases slightly. monthly at 65-70 billion euros per month between October and March 2022 (from 80 to 85 billion euros currently).
All of these uncertainties point to significant volatility for the FX EM space going forward. While growth is expected to remain a challenge, most emerging markets have started to feel the inflationary heat (albeit seen as transient) thus increasing the political dilemma. The surge in commodity prices should also weigh on emerging economies dependent on imports (India and Indonesia).
Several economies (Brazil, Russia, Mexico, Turkey, Czech Republic and Hungary) have already raised rates to counter inflationary threats, while others will struggle not to follow suit if inflationary risks persist.
Following the global indices, the Rupee also experienced huge swings in FY 22, ranging from 72.32 to 75.65. After being one of the worst performing Asian currencies in April, the rupee emerged as the best performing in May amid favorable sentiment for global risk, aided by the Fed’s assurance to continue to accommodate, the capping of the national Covid curve, the moderate trade deficit and the limited intervention of the RBI to curb the gain.
More recently, however, the rupee has weakened again by around 1.9%, following high crude prices and the strengthening of the US dollar. A notable feature of the rupee movements has been minimal interventionist behavior by the RBI. This makes it clear that while the RBI’s huge currency cushion will protect the economy against severe external shocks, it is unlikely to be significantly resilient to widespread weakness in emerging currencies resulting from global factors.
While the spot forex market saw a relatively weak RBI presence during fiscal 2022, the futures market continued to see reasonable action, but in reverse. After an aggressive payment from the RBI in FY2021 which kept the term premium considerably high, RBI began to unwind its huge long-term US dollar portfolio (not just the scheduled April-May21 maturity, but probably also with the early delivery of its due date in the first week of June).
Market chatter suggests that a plausible reason for this sudden change in RBI behavior is to reduce the cost of hedging REITs as India moves closer to inclusion in global bond indices. 1-year premiums collapsed to an intraday low of 4.12% in early June 2021, from a high of 5.45% in mid-May. The RBI’s long-term position in the US dollar is expected to have moderated to $ 43-45 billion from the peak of $ 73 billion recorded in February 2021.
The recent upward movement in premiums suggests that RBI is only taking partial deliveries of deadlines and rolling the rest, indicating RBI’s comfort with the current range.
Overall, as markets begin to integrate the normalization of global policies, the strength of the US dollar and rising crude oil prices are expected to weigh on the rupee. We expect the RBI to intervene intermittently to avoid strong weakness in the rupee to limit the transmission of imported inflation given the surge in input prices and the persistent and high core CPI inflation. .
Any intervention by the RBI to curb the fall of the rupee will partially offset the injection of domestic liquidity resulting from term deliveries and therefore also provide bandwidth to support the government’s borrowing program.
For now, in the short term, until further explicit signals to decrease from the Fed are provided, we expect the USD-INR to remain in the current range of 73-75.50 in the short term. However, narrowing interest rate differentials, advances in vaccination and the price of crude should keep the currency outlook volatile. We expect the USD-INR range to move towards 74-77 in 2HFY22 as markets begin to struggle with widening current account deficits (from an estimated marginal surplus in 1QFY22), volatile capital flows, growth-inflation trade-offs and the resulting normalization of global politics. .
Source: Kotak Mahindra Bank