- July 6, 2020
- Posted by: Amit Pabari
- Category: Currency
Lots of market participants must be wondering about sudden rupee appreciation? Rupee’s stability at a time when news flow was unfavorable and RBI bought a significant amount of dollar, reflected the resilience in the pair.
Last week’s appreciation is merely due to heavy inflows in the Reliance Jio platform from Facebook which was due to hit the markets.
However, more than rupee appreciation what surprised the market is that RBI broke three months’ trend of buying dollars by standing tall against sharp appreciation, at a time when market players were anticipating heavy investments from foreign entities into Reliance Industries.
Then why RBI had not supported Rupee against appreciation?
In our last report, we had given a target of 74.50 levels backing up with the reasons that could possibly drive the same. Adding to the list of reasons is the one given below which could further extend the momentum in the pair.
On June 29, RBI had announced another round of “operation twist” worth Rs 10,000 crore each, under which, it said to sell short tenor government securities and buy long-dated government bonds. This is being done to flatten the yield curve or the spread between short term yields and long term yields. Off late, the spread between 91-day Treasury bill yield and 10-year government bond yield is around 261 bps, highest in nearly 10 years. RBI took this move in an attempt to bring this spread close to end of last year i.e. between 125-150 bps and get the premiums down for cheaper borrowings. Buying long term securities would bring down long-term interest rates in order to stimulate private sector borrowing.
The recent release showed India’s fiscal deficit in the first two months through May stood at $61.67 billion, or 8.6 percent of the budgeted target for the current fiscal year indicating the government was front-loading its budgeted spending to combat the impact of the pandemic. Considering the jump in consolidated borrowing needs of the centre and state governments, RBI might increase the scale of its operations and come up with an additional Rs 50,000 worth Operation Twist or/and OMO’s.
Also, this helps to drain liquidity in the system because short-term interest rates have been falling as liquidity surplus has been used to buying short-dated assets. The banking system is currently having a liquidity surplus in abundance which has not been deployed fully in the economy with the fear of an increase in the NPA. At this point, further injection of rupee liquidity into the system by way of buying surplus dollars from the market may prove to be an incorrect strategy from the liquidity perspective. Hence, allowing the rupee to appreciate a little may not necessarily cause much damage to the economy, and that maybe the new thinking and focus for the monetary authorities.
In nutshell, when RBI does operation twist and if it continues to buy dollar at that point of time, it pumps rupee liquidity into the system which shall nullify RBI’s motive to remove excess liquidity prevailing in the market at present. Therefore, RBI has taken a pause in loading its Forex Reserves and has let rupee have its desired strength.
Rupee has changed its trajectory from stable to stronger side after having traded range-bound within 75.00-76.20 for the last two months. The pair is making a lower high pattern on the daily chart. Now the support for the pair shall remain near 74.50 levels and resistance is at 75.50 levels. If the pair breaks this support due to the pipeline of inflows and RBI halting dollar purchase, it is shall give a momentum of 80 paisa to 1 rupee on the appreciation side. Going forward, the pair is likely to trade in a broad range of 73.00-75.50 levels for the next few months. Therefore, upticks above 75.30-75.60 levels could remain a selling opportunity in the near term.
Witnessing the RBI’s change in stance coupled with the government’s requirement of funds, it is likely that RBI might do more such operations which could bring rupee near 73.00-73.50 levels in the medium term.
However, exceptional Black Swan events like an escalation of unrest between India-China and US-China could bring some unexpected moves on the dollar-rupee pair. Not necessarily and war, but every a friction between the two could cause the rupee to move back towards 75.20-75.50 level. That has to be taken as an opportunity to sell as the overall view remains “Sell on Upticks”. As the impact of any domestic events doesn’t last on pair for longer compared to the global trend, any sharp depreciation could be restricted. Overall, considering the present scenario, there is a 65-70 percent possibility that the currency shall move towards 73.00-73.50 levels within the next 2 to 3 months’ time frame.
Strategy for Export: Exporters who haven’t covered earlier between 75.50-76.00 levels are suggested to hold and maintain a strict stop-loss of 74.50 levels. If that breaks, they can begin selling aggressively. Overall, any uptick driven by a negative event near 75.30-75.60 shall remain a selling opportunity for the near term.
Strategy for Imports: Importers can buy their one-month payments close to 74.50 levels. To hedge more than a month, they can buy at the money call option in order to keep the downside open.
-Amit Pabari is managing director of CR Forex Advisors. The views expressed are personal.