INR Monthly Outlook – April 2022
The Rupee was in a reactive mode throughout March and continues to be in a position where it is being tossed about due to external events rather than internal factors. The prime mover- of course, last month was the Russian invasion of Ukraine, and this affected all markets- oil, metals, agriculture, foreign exchange, equities as the west chose to get involved through economic sanctions against the invading power.
Starting from a low at 75.30 the rupee took 5 trading days to peek above the 77.00 level before meeting a wall of selling (and sell-buy swaps) by the Reserve Bank of India who kept up steady pressure to help the local currency close below 76.00 (at 75.90) at the end of March. The entire focus of the market was centred on the day-to-day developments in Ukraine in as much as it was affecting prices of Oil, Wheat, Nickel and Natural Gas- Russia and Ukraine between them are major commodity suppliers and the combination of disrupted exports and applied sanctions sent various markets into panic mode.
Over the course of the month some surprising developments have started becoming apparent and the first was the resilience of the Indian equity markets without foreign investor participation. March was the 6th consecutive month of net FII withdrawals- touching INR 410 billion of net market sales, with just under INR 1.5 trillion over the six months from October 2021. Normally this would have meant a much lower Nifty/ Sensex but the Nifty has just crossed 18 thousand again- higher than at the start of October. The market has found domestic replacements (by way of demand) for USD 20 billion within 6 months at the same level of confidence! This makes dollar prediction much harder now given the inverse relationship that existed for 2 decades for index levels to dollar direction.
Earlier also, this level of sustained market selling- along with dollar repatriation would have meant a runaway dollar. But, USD 20 billion means a lot less in the RBI kitty than it used to. In that same time period the dollar has gone from 74.15 to the current level of 75.50 (by the scenic route of 77.00 but there are other factors involved there too)- less than 2% depreciation. That becomes remarkable given that- in that same time period, Brent oil has climbed from $78 a barrel to $104 a barrel (also taking in the sights at $139 at the start of March). This was building up much before the invasion and the spike in March reflected the fear that Russia- the largest oil exporter in the world (2nd largest crude oil exporter after Saudi Arabia) would face disruptions in selling due to the sanctions that were announced by the West almost immediately. But, given that Europe has a 40% dependency on Russia for gas supplies (over 50% for Germany alone) and they exempted gas payments from the sanction facing banks it became clear that the developed nations had little moral standing in forcing sanctions on others. Indeed, India has nearly come to close an agreement to buy Russian supplied crude at a $35 dollar discount to the pre-war price! That would equate to a price in the $60-$70 range for 2022. The details are yet to be finalised, but this represents a significant economic windfall for the Rupee- especially as the trade may be conducted through a Rupee-Rouble route, bypassing the need for India to buy foreign exchange. The Russian have forced the Europeans to pay for their gas through Gazprom Bank which converts their payment into Roubles bypassing the sanctioned banks.
Going forward, and with the effects of the war receding in importance (since many of the unknowns are getting resolved) the markets will start to focus on economic factors once again. Of particular interest is US rates. With the latest inflation print at 7.87% and unemployment claims down at 3.6% as 431 thousand jobs were added last month alone, it’s a no-brainer that the Federal Reserve is going to hike rates soon. The bet is that they will go for a 50bp hike in one shot and then a series of 25bp hikes in succession throughout the year. They have tried to counter inflationary pressure from the oil shock through the announcement of a release of 1 million barrels per day from their strategic reserves for 6 months but they will not be able to curb the growing demands for wage hikes across the organised sector. Companies- despite record profits last year, are also hiking the cost of products- citing inflation. This adds to the circular pressure of inflationary expectations which leads to higher wage demands and so on. The US is going to raise rates- of that we can be certain. The question is by how much? Expecting a 200-250bp hike by the end of 2022.
What does that mean for India? We know that inflationary pressure has been building up here as well. The February print showed inflation at 6.07% and that was before oil prices spiked. To an extent India will be well served with the oil deal that Russia is proposing. Another similar deal with Iran may also be in the pipeline. These will help quash some inflationary pressure. Wheat is not a problem since India produces a surplus (Ukraine is the world’s largest exporter and the war has driven up international prices) so there is some insulation for the economy. Part of this realisation is showing up in a buoyant equity market. But this will not change the fact that rates will have to start to climb to keep inflationary pressures being imported from overseas. A 50-75 bp hike by the end of FY 2022 may be in store.
The US Dollar looks like it may explore some further downside against the Rupee during the first half of the month- providing Russian engagement in Ukraine continues to wind down as it looks for a face-saving exit from a disastrous campaign (and before the Ukrainians start getting re-armed by the West). A possible test of 74.40 is not ruled out and an upside of 76.30 will hold mismatches of flows. The arrival of funds for the LIC IPO may occur this month- given the bullish sentiment in the Indian market currently, and that would be INR positive. The negative jolt would have to come from a sudden sentiment shift- the probabilities weigh against this currently.