1) Performance of the US Dollar globally:
With the US Fed preemptively cutting rates to zero and committing itself to infinite QE, the US Dollar funding cost is extreme low. Therefore, we have not seen the same kind of US Dollar strength that we typically associate with extreme risk aversion in times of crisis like these.
2) Outflows from capital markets:
FPIs have sold domestic equities and bonds to the extent of USD 17bn in a month. FPIs are now utilizing only 53% of their limit in Gsecs and 40% of their limit in corporate bonds. With concerns over imminent fiscal slippage, the spread of Gsec yields over repo and that of SDLs over Gsecs have widened to alarming levels.
3) Incessant pressure from offshore:
One month offshore USDINR forward (NDF) has traded 80-100p above onshore consistently for almost a month now. That pressure is spilling over to domestic futures and OTC as well. As a result of this, every dip in USDINR has been shallow and has been bought into aggressively, despite numerous instances of central bank intervention in OTC and exchange traded futures.
4) Low liquidity:
With banks and corporates operating from home, the volumes have tapered off drastically. OTC volumes are estimated to have become one third. Price moves have been exaggerated amid thin liquidity and this has promoted the central bank to reduce the trading hours in OTC
5) Liberalization of capital account:
Amid the current gloom, an array of hope for the Rupee stems from Liberalization of capital account. FPI limit in stocks has been increased to respective sectoral FDI caps. This will result in passive flows into Indian equities as an increase in foreign ownership factor will lead to increase in MSCI India weightage by 0.55% in the MSCI Emerging Markets index.
The RBI has also announced a Fully Accessible Route (FAR) for FPIs under which there will be no restriction on FPI holding of government securities. This is one of the prerequisites for inclusion in a global bond index. Other measures to facilitate inclusion such as increasing Rupee trading hours onshore, access to exotic derivatives have also been announced. Index inclusion therefore seems a priority for the RBI at this point.
6) Crude oil price:
Lower crude prices will provide some respite but during times of extreme risk aversion it is often the capital market outflows that tend to have a predominant and more pronounced impact on the Rupee. The current account deficit is likely to narrow significantly as imports would fall more than exports.
7) The RBI reaction function would also be extremely crucial. The RBI has done a reasonable job of containing the Rupee so far. A spike in volatility could lead to further acceleration in capital market outflows. Panic would also set in among those who have unhedged ECBs and among exporters who have sold Dollars forward and are now looking to cancel these contracts as their shipments are getting indefinitely delayed/cancelled. Therefore, it is likely the RBI will continue to intervene to keep the volatility in check.
Overall, there seems to be little disagreement among market participants about the direction in which the Rupee is headed over the medium term given the expansionary monetary policy and fiscal policy. What the market participants are divided over is the pace of Rupee depreciation from here on. However, if Coronavirus induced disruptions exacerbate, amid fiscal concerns we may see another 3 - 4% follow-up move in USDINR to new all-time highs.
We put together our take on the major domestic and global factors driving risk sentiment over the medium term with special emphasis on political developments, monetary policy outlook and fiscal policy implications.
We may see some volatility on account of domestic election results in the sh...
Quant based FX Advice.Subscribe for exclusive access.