Rupee Continues to remain in a no Trend Phase

By Anindya Banerjee:

Rupee continues to remain in a no trend phase, with 61:00 and lower acting as a strong resistance on the local unit due to alleged strong defense from RBI and at the same time, a broad global rally in USD also tempers bullishness in the Rupee. However, depreciation beyond 61:80/62:00 is not happening now as exporters, FIIs and carry traders are comfortable selling the Greenback. On a peer to peer comparison Rupee continues to appreciate.

Value of one fiat currency against the other is largely determined by the relative attractiveness. Net demand and net supply is what determines whether one currency appreciates or depreciates against the other. For the Indian Rupee, last 12 months have been a game changer. A mix of internal and external factors, which were acting as headwinds till last year, has now reversed polarity, and is now offering sizable positive momentum. Interest rates in the country, after adjusting for inflation is now positive by a decent margin and is expected to remain so over the short to medium term. A positive real rate is considered deflationary for the economy and hence improves the relative attraction of the Rupee. At the same time, GOI has shown remarkable political will in restraining fiscal expenditure and hence the deficit. Once the economy picks there will be tax buoyancy, in which case, the fiscal deficit can shrink further over the medium to long term. Fiscal prudence is once again deflationary and also thereby adds to the positive pressure on the domestic currency.

A sharp decline in global petroleum prices has become a major boon for an oil importer like India. Lower petroleum prices shrinks current account deficit and also lowers fiscal deficit. At the same time, lower oil prices leads to a down ward shift in the cost curve of all goods and services and hence increases the disposable income of households. India consumes around USD 1.25 billion barrels of crude oil every year, hence a drop in oil prices by 20/25 dollars a barrels leads to a cost saving of around USD 20/25 billion in a year. Higher disposable income boosts aggregate demand in the economy, which can be precursor to pick-up in the investment demand. As a result, the economy enters a virtuous cycle of higher growth and lower inflation.

Indian government has recently relaxed the norms for foreign investment in the construction sector. India needs to be build world class infrastructure at an affordable cost of funds and this can be achieved by allowing greater participation of foreign capital. GOI now needs to focus on the key areas like land acquisition, labour laws, tax regime, power sector, privatisation of PSUs, bankruptcy laws, deepening of financial markets and last but not the least, effective regulation and power to banks to deal with NPAs. There is hope that government remains committed to above mentioned reforms and hence we see considerable support for the currency over the medium to long term.

Over the near term, we need to keep an eye on the developments surrounding the 'black money" proceedings. India is yet to ratify two major global treaties on sharing of information on illicit money. India needs to ratify the FACTA accord, Foreign Account Tax Compliance Act by the end of 2014. Under the law, Indian firms dealing with US nationals or having business in US, will have to disclose information to US tax authorities. Similarly, US alongwith other signatories of the FACTA will share information with India on its citizens financial activity in those countries. However, under FACTA, Indian government would have to maintain secrecy of whatever information it receives from the member countries. Incase India fails to ratify the accord then its businesses and financial institutions can face penal tax of 30% on inflows from the members countries. The apex court in India is expected to pronounce its verdict around the first week of December. We have to keep a eye on the proceedings as incase the Supreme court prohibits GOI from ratifying FACTA on grounds of embedded confidentiality clause, then it can have significant adverse effect on the Rupee.

We have seen a U-turn in the global financial markets, where, a mix of financial intervention and verbal intervention, from the BOJ, US Fed and ECB, has triggered a massive risk on play. Indian equities and debt have benefited from the same. BOJ announced fresh measures to ease monetary policy. Bank of Japan will now expand its monetary base at the rate of 80 trillion yen annually, from 70 trillion yen previously. At the same time, the domestic pension fund, GPIF is expected to announce doubling its allocation of funds to domestic equities and foreign equities, at 25% each now. All in all, global liquidity gets another shot in the arm. We expect the Yen carry flows to rise in the coming weeks and months on account of the above policy shifts. India will remain a major beneficiary of the same and hence Yen and EM equities will become further tightly negatively correlated.

Globally central banks are in no mood to allow any kind of structural damage to the manufactured bull market in risk assets that they have successfully engineered since 2009. However, trying to micro manage financial markets is akin to playing with fire, as years of forced stability can breed greater and significant instability down the road. Therefore, it is much better to heed the caution from saner voices of the likes of Dr. Rajan, who has openly criticised on the overindulgence on QE.

Global economic data over this week was mixed with Germany reporting poor business sentiment data for the month of October (IFO). Euro zone credit contracted further in September but at a slower pace. US durable goods orders had contracted in September. US GDP rose at 3.5% in Q3 after rising 4.6% over the previous quarter. A sharp rise in government spending drove the economic growth upwards. Inflation data from Euro zone members continued to point towards low inflation to deflationary scenario in the currency union. In Japan, household spending declined by more than forecast in September. Inflation in Japan came in lower than forecast in October. ECB's just concluded stress test of the Euro zone financial institutions failed to inspire confidence, as the central bank failed to account for deflation in the worst case scenario. Modelling a euro wide deflation would have led to a sizable increase in bad loans under the worst case scenarios.

Over the next week, traders will keep a close eye on the flash PMIs from major European economies as well ISM PMIs from US. US economy is also scheduled to release its monthly non-farm employment numbers. At the same time, Chinese and UK PMI will offer a glimpse into the state of their respective economies. Both, central bank from UK and Euro zone are scheduled to announce its monetary policy. Indian economy is going to report the PMI data for the month of October. Indian Rupee is expected to trade within a band of 60:70/61:00 and 61:80/62:20 over the next couple of weeks. Large options OI at 61 strike put option and 62 strike call options on NSE confirms the above the range. Rupee can continue to appreciate against Yen and the Euro. Against the GBP, it can remain ranged.