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USD/INR to trade between 58-59 over the next 18/24 months

Monday, August 07, 2017
By Anindya Banerjee

Anindya Banerjee
Currency Derivatives Researcher, Kotak Securities

After many attempts to break below 64.00, Rupee bulls finally managed a weekly close below that threshold, at 63.57 levels on spot. Indian Rupee’s Bull Run can be summed up in few words: overt and covert phases. The covert phase, or the stealth Bull Run occurred between September 2013 and January 2017. Since then we have all witnessed the overt phase, which has caught many by surprise. We turned bullish on Rupee against USD during the early part of February, when the pair used to trade between 67.00 and 68.00 levels on spot.

Dollar Rupee, like any other currency pair, is driven the three set of factors, M-I-P. M stands for macroeconomic. I stands for inter-market trends. P stands for positioning. Macro can be further broken down into three legs: R-G-P differential between US and India. R stands for real interest rate outlook. G stands for growth outlook. Finally, P stands for political climate.

RBI, under Dr. Rajan, adopted real interest rate as a formal policy objective. Having done so, RBI ensured that they kept real rates positive, above 150 bps. In order to achieve positive real rates, government and RBI went on to enact conservative fiscal policy as well as neutral to hawkish monetary policy. Even though RBI normalized rates from north of 8% to 6%, but they did so with a significant lag to inflation. Policymakers realised that a stable to strong currency is the need of the hour and the way to ensure that, would be to keep real rates positive. As a result, even though Rupee depreciated from 66.00 to 69.00 from August 2013 to January 2017, but it did at a pace slowest amongst its peers. Therefore, Rupee managed to score the best performing currency tag in the EM region during those 3.5 years.

Though high real rates is what drives a currency higher or lower but the other two factors can also play a decisive role, growth and politics. If market expects growth to weaken to a point where it can significantly reduce the real rates in a foreign currency or if the market senses that the socio-political instability is on rise, foreign investors and speculators can ignore high real rates. Indian Rupee has managed to score sustainably on all the three fronts, high real rates, improved growth outlook supported by supply side reforms from government and very high credibility of Modi’s team. Result, has been a currency which has risen from the ashes of bad economics of UPA to become a strong currency.

Inter-market picture started to turn against USD, around the early part of 2017. Quite expectedly, Trump focused more on controversies than on governance. Lack of progress in areas on healthcare, tax reforms, infrastructure spend and trade prompted currency traders to abandon their longs bets on USD. A weak USD, ensured that Rupee which was already in a bull market against almost all of the other major currencies, now gain against US Dollar too. Since March, positioning has flipped on USD. Traders and hedgers have switched from being long in USDINR are now short. Some may rightly complain that the positioning appears crowded on short USD. We concur, that over the medium term, there lay possibility of a short squeeze in US Dollar, lead by a deep correction in global equities. However, the long term or structural trends remains firm for the Rupee. As a result, over the next 18/24 months, we can expect to see USDINR trade between 58.00/59.00 levels on spot.

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