2022 begins with the rupee looking positively rejuvenated against the US Dollar. After hitting highs in the mid-76 range midmonth the rupee bounced back and is ready to take on the new year in a positively perky frame of mind. Domestically the indicators look good overall and so the confidence is not misplaced.
The trend of the last two years suggests that the rupee has settled into a sideways trading range against the dollar with boundaries set at 72-77 for the moment. In 2020 we saw the peak early on in the pandemic panic but the currency pair behaved with relatively stability in the intervening period- that is, until the Delta Variant hit India hard. The last 6 months have seen the dollar start an uptrend but the four sharp rallies since April 2021 have seen almost equally rapid reversals bringing us nearly back to the starting point.
Fig. 1: USD/INR 2020-2021
Source: investing.com
And, although the uptrend channel is still in play it looks like the move will be marked by a lot of two-way volatility and schizophrenic predictions as the market looks to make sense of the movement.
The key driver of the up-move last month was the raised expectation that the Federal Reserve would begin a tapering of the supporting liquidity they have been providing the market since March of 2020. With inflation in the US also running hot there was the expectation that the tapering would be at an accelerated pace and would quickly lead on to the rate hike part of the normalisation process. The UK bit the bullet and raised key rates 25 basis points and it looked like the US would also follow. Once the news was out of the way the dollar gave up most of its gains rather rapidly.
The dollar is likely to find takers consistently in the medium term, however, given that a lot of carry trades will look to completely unwind ahead of a rate hike schedule which could potentially erase a significant portion of their gains. This applies equally to many equity funds that would find their funding costs rise. The questions regarding the Fed are: how soon will they start?, how fast will they hike? And: where would they take it to?
The consensus at this point suggests a May/June timeline for beginning the rate hike cycle but this is really dependent upon a lot of factors- especially the Omicron variant that is currently the dominant strain of Covid-19. By most accounts it seems to be relatively benign though highly contagious. Assuming- like South Africa, the outbreak peaks and subsides equally quickly, then global output will face minimal disruptions this year and things can get back on track sooner than later. This will be dollar positive.
These then have to be weighed against the attraction of the Rupee. The Indian economy is poised to be the world’s fastest growing (large) economy this FY (April ’21 till March ’22), with official estimates at 9.5% GDP growth. And, though the equity markets are more expensive than others in the Emerging Markets stable (nearly 1.9 times the average PE of the MSCI Emerging Markets bunch) growth is the most likely guarantor of profits and therefore, capital appreciation; this alone will keep overseas investors in the fray. Inflows into the economy will keep downward pressure on the dollar.
US inflation is expected to remain elevated through the first half of the year even though the current administration has been quite successful in tackling the supply chain issues that were aggravating inflationary pressures last year. But this will not affect the increasing number of union-led wage revisions being negotiated there and neither will this reverse the rise in food prices being witnessed globally (partly due to changes in weather patterns globally affecting crop output). Nor will it have any effect on oil prices which have been rising consistently from March 2020- including a 50% rise in 2021 alone but is still within comfort zones. A break above the US$ 85 per barrel area could trigger a move to the $100 level which will be inflationary globally. OPEC+ is meeting on the 4th of January and the market will look to see what they decide on future production levels. They are committed to raising production by 400 thousand barrels a day from February. Will that be enough to offset rising demand as the world comes out of lockdown?
This month looks neutral for the rupee but there is this underlying feeling that this is skating on thin ice. As pointed out earlier the US is closer to pulling the trigger on its liquidity support and rate hikes. Regardless of strong fundamentals locally this is a pricing issue for discretionary asset allocation and there will be pressure on the Rupee as soon as we see the first hint of a US move. The dependence on USD funding is critical and has been a major factor in the MSCI 50 country world index rising 20% last year and adding USD 10 trillion to equity valuations. Indian equity itself saw a 23% gain in the indices last year but valuations are extended given that we have had marginal overall GDP growth over the last two years combined. The Business Confidence Index shows a 55.5 reading for Manufacturing in December- reasonable enough though lower than expectations. Inflation is still under control and within the broad band that the RBI is comfortable with. The Current Account Balance has again slid into a deficit with a goods deficit partially offset by a services surplus. Government Debt is high at 74% of annual GDP but this is lower than the US (128%), UK (95%), the Euro area (98%) and Japan (266%). This will have increasing relevance as the year unfolds- especially when the rating agencies decide on the Investment grade to assign India- teetering on the edge between investment and junk bond status.
Technically, if we remain within the rising trend channel on the charts we could see a 73.75-75.25 range hold for the month. The government has a disinvest programme that includes offloading stakes in both LIC and BPCL by Q4 (Jan-Apr). Apart from helping bring down the budget deficit this will be a positive for the rupee.