Is USDINR heading to 78.0 next or to 74.0 ?

USDINR recently moved to 75.0 and now is back to 76.0. Question is where is it headed next? To answer that question, we need to first examine the key factors which are driving USDINR at this stage –

1. Current Account Deficit

India’s current Account deficit may turn into surplus for the current quarter. Even before lockdown, CAD was only USD 1.4 bn. on quarterly basis. Now the oil price has crashed, reducing the trade deficit by 30% in April. Even though remittances and exports will be down, most likely we will see a balanced current account.

2. Virus 

COVID19, which created the current crash and volatility in the market is still very much there. In Europe, East Asia, South-east Asia and in New York we see virus virulence slowing down both in terms of mortality and new cases. This is positive sentiment for the market since key financial centres in the world are seeing improvement.

However the risk continues in India with an increasing daily trend in the number of cases as well as in number of deaths. Even globally a second wave is possible as we can see inching up of cases in Arizona and Texas. We need to remember lock down will be back if infections become overwhelming like it was for NYC, London, Italy and Spain.

3. Federal Reserve 

Most important factor driving the market at this stage is the USD 3 trillion balance sheet expansion by the Fed. This balance sheet expansion comes along with expectation of zero interest rate for a long period in the USA and also a dovish picture painted by Powell.

The Fed is not acting alone, ECB, BOJ has also pumped unprecedented amounts of liquidity into the system. So a world flushed with liquidity and encouraged by Fed’s support is looking for yields and hence the USD funds are flowing in all risk assets including EM and India.

4. RBI

RBI is sitting on a whopping Fx reserve of USD 501 bn. They possibly bought USD when rupee moved close to 75.0. It is clear that RBI is not in favour of too much of INR appreciation and at the same time they have significant wherewithal to fight any sharp INR depreciation. RBI will possibly continue the support from both sides especially since too much of INR appreciation will erode RBI’s ability to provide dividend to Government. A weak rupee also hinders import and supports export – Atma Nirbhar cause.

5. Real economic slowdown

In India both financial sector and MSMEs are seeing significant solvency and business issues. Capitalization will be required. Business losses, profitability reduction, job losses, salary cuts, bankruptcies can be expected in India in the coming months. On the one hand, these reduces attractiveness of India for foreign investors but on the other hand opportunistic foreign funds will be coming to buy good assets at reasonable prices.

Indian economy needs fiscal stimulus. Financial sector will require more capitalization. The steep yield curve denotes discomfort of the market about how India will manage the challenges. On sovereign rating, India is just at investment grade level and if one notch downgrade happens, that will take it to non-investment grade.

But financial markets are certainly way ahead of economic recovery at this stage and as lockdown ends and moratoriums lifted, the pain will be felt across.

Overall macro-economic weak standing of Indian economy and specially that of financial sector will be a sore point.

6. US-China, Trade war, US election

US – China rhetoric has taken a backseat at this moment but it’s a matter of time we will see it coming back since the US election is there in November. Anti-China sentiments run strong globally and any trade or capital restrictions will lead to CNY depreciation and along with that will put pressure for INR depreciation.

 The risk of INR moving to 73.0 or 72.0 is less since RBI will be standing in the way of foreign inflow. A level of 79.0-80.0 is unlikely since the Fed’s 3 trillion will push the market’s appetite or take risk.

 Now considering all the factors, we feel USDINR will be moving in a range for the coming months. A safe range of 74.0-77.0 can be considered appropriate. A narrower range of 74.50 to 76.50 is more likely.

 In such a rangy market generally the buy low , sell high approach of Fx hedging works better compared to the “trend is my friend” approach.

Caution

Having said this, we need to warn you about two points related the view –

1. Views are a probabilistic approach and with new unforeseen events, information is reassessed from time to time. So be in touch with us for regular updates of market assessments.

Similarly, If significant FPI inflows come to India chasing yield and RBI stops intervening aggressively INR can go to 72.0-73.0 levels.

2. Hedge strategy is more important than view.  Only when you combine a good hedge strategy with view, then savings / profitability enhancements will come. So refine your hedge strategy to bring in best practices. Do have an optimised hedge strategy.