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Year 2014 comprises two halves for the Indian markets, the dividing line being the result of general elections. In a broad sense, expectations on the $/Rs foreign exchange (FX) rate and interest rates are of muted volatility and trading-in-a-range pattern for the pre-election period. Equally strong are the expectations that the election results will lead to a strong directional move in the currency in the second half.
FX dealing desks expect the rupee spot rate to range between 61 and 63.50 for the time being. Such a tight band implies presence of a strong buyer or seller at the respective ends. Traders witness that oil marketing firms are a large buyer at the lower end of this band. The dollars collected so are being used to repay the dollars they took from the Reserve Bank of India (RBI) under a swap facility in 2013 and to hedge forward dollar demand. One estimates it may require net inflows of more than $15-20 billion in a short time for the lower band to be tested. On the higher end of the band, traders expect RBI may intervene as it has built up its reserves holdings over recent months. This expectation, in turn, is leading exporters to be more aggressive sellers of forward dollars at the higher end.
Of course, believing in such tight ranges is only possible when the associated macro risk factors have been somewhat mitigated. Concrete steps, taken by the government, to tame the current account deficit is the most important driver in calming the expectations to a narrow range. Add to that, the government’s continued commitment to deliver on the fiscal deficit target. Global risk factors also remain. However, such is the strength of these macro improvements that rupee was one of the least hurt currencies in the recent bout of falls in emerging markets across the globe, triggered by the Argentine Peso.
RBI has now sharpened the focus of its monetary policy objective towards consumer inflation. While meeting this has its own challenges, controlling inflation expectation through such objective-setting benefits the expectations on the currency. RBI’s move to raise the policy rates corridor by 25 basis points in January citing core consumer inflation is a demonstration of willingness to act towards the objective. Given high interest rates in India, lowered inflation expectations become a strong reason for attracting foreign capital inflows, as it is hard to get positive real returns globally. We are yet to see such flows, nonetheless, it is recognised that the macro of inflation is being addressed.
Another reason for the belief in a range, may, perhaps be the RBI’s removal of restrictions on freely cancelling and re-booking of FX hedges by exporters and importers. It helps users to hedge for their desired amounts, based on their internal risk management policy, instead of rationing their hedge amounts. If the broad view is of a range-bound market, the action of exporters and importers may enable further strengthening of the ranges.
In the pre-election period, the Fed’s tapering related risk is understood well and priced in. However, another global risk factor worth keeping an eye on, is the developing credit quality deterioration in China as its growth slows down. Should there be an implosion of growth in China on account of a disrupted credit flow, it will create consequences for emerging markets including India. In this Year of Horses let us hope that China manages to keep these risk-horses in the stable.
The author is managing director, head of fixed income & currencies, Deutsche Bank, India. The views expressed are personal
