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USDINR depreciated to 72.0 levels and RBI is kind of holding on here. Indian 10Y yield has also reached 8.10% signifying possible rate hike in coming months. Question is what next for USDINR?

Let’s look at the primary factors which are at play for USDINR –

Trade War: Tariff and verbal trade war between US and others (primarily China and other exporters to the US) has led to USD strength and weakening of CNY and other peer currencies. However, the very recent move of INR has nothing to do with a trade war. CNY remains stable at 6.84 while INR depreciated by 5% to 72.0 levels. I feel the impact of a trade war on USDINR will be negligible going forward.

Emerging Market Crisis: Some emerging markets currencies are taking a beating like Turkish Lira, Argentine Peso, South African Rand etc and unfortunately Indian Rupee is in the same bucket thanks to increased CAD though on many other parameters India is not part of these group. GDP Growth, Fiscal control, Fx Reserve, External dependencies etc. for India is much better than peer group along with whom INR is depreciating.

Crude Oil price: The crude oil price has been the primary culprit behind changing India’s CAD sharply. However, a sharp rise in Crude prices from the current level is a bit unlikely.

Now coming to the most important factor behind the current move – Current Account Deficit. Last few Trade deficit numbers signal monthly trade deficit run rate of around USD 17 bn. Non Trade surplus like NRI remittances and Services surplus will be around USD 10 bn. and hence leaving a USD 7 bn. of monthly CAD to be financed by FDI FII and RBI. FDI will be around USD 3.5 bn a month and for the remaining USD 3.5 bn a month we are dependent on FIIs. FIIs do bring that much of inflow in a normal market, however during such turbulent times they cause outflows. So the role of RBI is to smoothen the flow. Considering India has grown to be a USD 2.5 Trillion economy, around USD 80-90 bn. the deficit is close to 3% of GDP. Considering that INR has moved up significantly from 64 levels to 70.0 levels the CAD also should adjust itself. I would assume if INR remains close to 70 levels, CAD run rate will come down to around 2.5% of GDP assuming stable crude prices. CAD will continue to be a problem but will be not a recipe for disaster for INR.

Now let’s discuss central banks. First, start with RBI. In such tumultuous times, RBI intervention is key to market stability. Neither fundamental analysis nor technical analysis works. It’s between RBI and Market ( Savvy players like hedge funds, banks, traders). So if you are speculating and you know RBI will protect round figures for few days and then let it go, then you will keep buying at 69, 70, 71, 72, 73… and not cut your position because you know the next level is coming soon. Two methods of intervention can be effective a Japanese style intervention when the central bank comes with let’s say USD 10-20 bn and drives down the level from 72 to 70 or 69. Speculators will think twice before playing against INR again. However, this is not the style which RBI uses b) Next one is policy changes. Like curbing buying of USDINR in exchange, tinkering with PP Limit for importers and exporters, raising rates and sound hawkish, changing FII debt limit, offering booster to NRI for deposits ( like done last time) etc etc. While I am personally not a fan of such schemes, but we can expect such policy changes to come soon. And that will stabilize USDINR.

Now coming to the big brother of global financial markets: US Federal Reserve. The liquidity kept all asset classes comfortable starting from credit, equity, EM, fixed income etc. Now with continued hawkishness and rate hikes, US rates have come to a level which can create havoc in global markets. If Global financial markets fall like a domino with Dow falling, funds going bankrupt, EM depreciating further, Bank spread widening, speculation on banks going down etc. then we will see further fall in INR and RBI policy tinkering will not work. However, I would be inclined to believe that the US Fed can and will change their hawkishness into dovishness to avoid such a crash. The Fed-induced crash can be postponed for some more time.

Based on the above, I would say INR should be topping around 72.0-74.0 levels and then should stabilize around 70.0 levels. Unless Dow starts crashing and global sell off happens.

However, I have another view for corporates and that view always comes correct. The Correct view is “Any level is possible and hence focus on strategy, not on views”. On strategy, a broadly appropriate combination of option and forward for importers has been working well with extendable ranges. On export, the premium is in favor and hence a Systematic Hedging Program (SHP in line with SIP) has been the winning strategy. The speed of SHP can be changed from low to medium to high depending on the levels but slow and steady hedge works well as it keeps earning a premium and during a reversal, exporters are not left with the feeling of missing the levels. Another strategy which works well and has worked well recently is budget rate targeting.

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The Article has been written by Samir Lodha. To discuss how QuantArt can help you in optimising your forex strategy with Systematic Hedging Plan and special import hedging plan, just email now to prasenjit@quantartmarket.com 

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