Rupee gains to be limited despite lower crude prices

The recent gains of the Indian Rupee against the US dollar suggest that the worst for the local currency might be over but any significant appreciation from the current 72 levels will have to overcome the approaching political uncertainty.

Since February 2018, dollar Rupee moved up on account of various factors most of which now are fully priced in or have marginally tilted in Rupee's favour. The banning of buyer's credit transactions by the Reserve Bank of India (RBI) following the LOU scam led to substantial short-term credit unwinding. This unwinding would have got fully completed in a tenor of six-eight months and therefore the one time impact is behind us.

The recent unexpected fall in Brent crude prices from $80 per barrel to $67 has resulted in moderate improvements in the expectations for India's current account deficit for the current fiscal (from 2.75% of GDP to sub 2.5%). On the other hand, the government's resolve to keep fiscal deficit within acceptable limits helped by sub 4% inflation prints has resulted in India 10-year bond yields coming significantly lower than 8% (current at 7.75%). Expectations of further fall in bond yields plus the prevailing high real rates (3% plus) have resulted in small foreign portfolio investors (FPI) investments into debt markets as compared to large outflows that we witnessed for the last few months.

The rout in various emerging market currencies (Turkish Lira, Chinese Yuan, South African Rand) August onwards has now stopped and most of them have retraced significantly from their bottoms. Talks of a resolution being reached between China and US on the trade standoff front has resulted in moderate improvement in risk sentiments for emerging markets, in turn, helping the rupee.

While these factors have already led to a 3.5% appreciation of the Indian rupee, further gains would be slow and limited. The fact that India goes for union elections in May 2019 will ensure that further investment commitments to the country sit on the fence until further clarity emerges. In this regard, the December 11 state election results, would be keenly watched by the markets to assess the popularity of the incumbent government and could result in significant movement in dollar-rupee, equities and bond yields. Reserve Bank of India (RBI) since February 2018 has sold approximately $45 billion to arrest the pace of slide in the Indian rupee. It would be a rationale to assume that at sub-72-level RBI would aggressively want to rebuild it's reserved, limiting further rupee gains.

Assuming that the November 19 RBI's board meeting reasserts the market's current assumption, that its rift with the government is a thing of the past, one could expect small rupee gains in the coming week. For now, the rupee could be expected to stay in the range of 71.20 to 72.40.

The writer is senior group president, financial market, YES Bank

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