Top factors dominating USDINR as we start the journey of 2020

Here are the top factors dominating USDINR as we start the journey of 2020

1. Federal Reserve

While one can argue, that asset valuations are unreasonable and trade rifts will slow down growth and geopolitics will impact risk appetite, biggest stabilising factor for the market have been and will continue to be Federal Reserve.  Fed’s 3 rate cuts last year supported asset prices including equities and EM currencies and since September 2019 Fed’s action of asset purchase  to stabilise US repo markets led to an amazing stability amidst trade rifts and other concerns. The QE, which Powell doesn’t call a QE, has been proven to be a stronger tool than rate cut and hence Fed is confidently signalling no rate cut but they have clearly mentioned that they are committed to do more to keep repo market stabilised.

This commitment of Fed to support US and hence global liquidity with asset purchase, is the foremost factor behind a stable market and will continue to be so at least for some time. Need to keep a close watch on US repo market and money market rates, which entities are borrowing, is there increased stress, bank vs non bank borrowing etc.

2. Global Geopolitics and local politics

Geopolitics have come to the forefront with US strike of Soleimani of Iran. Iran has vowed to retaliate and Trump has also threatened that US will react fast and hard to any Iranian retaliation. The tensions in the coming days will put oil price upwards with Brent already trading at 68.00 levels. Any war in addition to the trade war will be significantly bad for global markets and risk sentiments. INR will be relatively more impacted compared to other EM currencies because of India’s oil dependencies and also because India shared a good trade relationship with Iran. This factor puts an immediate bias for risk-off including INR depreciation and equity softening. Safe Haven JPY is appreciating and US 10Y bond is seeing buying.

India is unlikely to be at peace in the coming months and the protests, political rifts will slowly start impacting economy and markets as well.  Specially foreign inflows which have supported INR a lot in 2019 may get impacted.

3. FPI,  FDI

2019 saw good inflow backed by global liquidity even though trade war, valuation, economic stress dominated headlines. FPI invested USD 14 bn in equities and USD 4 bn in debt and FDI in the 10 months was around USD 32 bn. ECB inflow has significantly increased and in the 10 months of Jan19-Oct19, USD 47 bn. has come as ECB inflow ( however this is not net ECB inflow).  ECB inflows primarily increased as regulations were relaxed around end use specially permitting stressed accounts to borrow ECB. Regulations around hedging also have been significantly relaxed and hence many companies can borrow on unhedged basis now.

Valuations remain high for Indian equities and inflation keeps outlook unclear for rates and hence FPI inflows in 2020 can be expected to be lower. However Government is pro foreign capital and hence we will possibly see increased privatisation, relaxations to attract FDI and ECB inflows. Believe a sovereign bond sometime in 2020 is a highly likely event.

So overall positive on foreign inflows since Government is extremely positive for the same.

A seasonality number for your reference : Last year March end saw ECB inflow of USD 12 bn.

4. Trade deficit and CAD

Since oil price has been contained and capped import subdued, trade deficit or current account deficit has not been a headache for India during 2019. We expect for next 3-6 months, it will not be a headache for INR however we need to remember that most correlated macro factor driving INR has been trade deficit in the past.

5. Reserve Bank of India

RBI policy and strategy around Fx always have a strong bearing on INR. RBI during last 12 months have accumulated USD 60 bn of Fx reserve which is largest accumulation in the world during this period. Our sense is RBI will be more protective of volatility than others during any crisis like situation for INR.  Hence it will not be easy for INR to move to either 69.00 or to 77.00.

Overall Assessment

Looking at an immediate range of 71.25 to 73.25.  Overall for the year, not expecting INR to move sharply to 78.0 or 80.0 and at the same time sustained appreciation of INR to 68.0 kind of levels will be unlikely. Most likely range for the year can be 69.50 to 75.50.  In another words moderate depreciation with volatility within a range and very low chance of sub 70.00 level is a likely scenario.

As always, view is only one part of risk management / profitability management and more important part is the strategy and appropriate use of instruments. We believe carefully crafted option based hedging will work better in 2020 than vanilla forward since moderate depreciation and forward premiums neutralise each other.