BOP – Current account deficit plus FDI flows should
continue to remain positive for the visible future. Although oil price is
expected to rise to 60-70 USD, the negative impact would be made up for
continuing investments into India through the FDI route given the higher growth
rate domestically. I would ignore the FPI inflows, as such inflows are more
likely to find its way into RBI’s reserves.
Fiscal Situation – The government’s track record
since 2014 shows respect for fiscal targets and with tax collection likely to
grow in 2017 (due to GST and demonetization impact on Direct taxes), a negative
view on fiscal situation is very difficult to form.
Inflation – RBI turned its stance from accommodative
to neutral in the February policy. Inflation is likely to be adversely impacted
because of rising fuel prices plus the technical impact of 7th CPC
HRA component. The pro active approach of the RBI shows commitment to 4%
inflation target and therefore an out of control price rise in the economy is
unlikely in the visible future. Historically inflation has been the primary
factor which has led to cascading effect on other parameters causing INR
depreciation.
Growth – The negative impact of demonetization seems
to have been lesser than previously envisaged mainly due to government spending
and agriculture. The local growth factors should improve as growth outlook for
other DM and EM countries look better for 2017 with inflation picking up in EU
and US, while China and other EMs seem to be better placed than they were in
2015 and 2016.
US interest rates and USD outlook – In 2015 US
interest rate hike expectations were spooking risk assets as the world economy
was much more fragile than it is currently. Recently (since Jan 2017) USD
strength has been accompanied by equity and EM currency strength (or stability
at least). Expectations of a fiscal stimulus in the US has also helped change
the 2015 response along with stability in China which was complimented by a
moderately appreciating Yuan this year. Thus USD strength on the back of
interest rate hike expectations in the US need not necessarily lead to INR
weakness. But in cases where a higher USD is accompanied by increasing
political risks in the EU or instability in China then INR weakness could
follow.
Given the above, why I still do not expect INR to
appreciate significantly from current levels of 66.85?
-
The economic survey of the government released
in Jan 2017 created 2 new REER indices for INR. According to both of them INR
is much less overvalued than the commonly referred to RBI REER index. Although
both of them still show an overvaluation of ~7% currently as compared to 16% of
the RBI REER index. These new indices, perhaps indicate that the government is
not looking to depreciate the INR in a hurry to achieve competiveness in
exports. But at the same time the existing overvaluation of 7% would prevent
the government to allow INR to appreciate substantially from here.
-
In the economic survey, the government argues
for using the excess RBI capital of Rs. 6 L crore to improve the fiscal health
of the government or to recapitalize PSU banks. This 6L crore is nothing but
the MTM gains that RBI has accumulated through its FX assets of Rs. 24 L crore
over the last 15 years as INR depreciated from 40 to 67. Therefore substantial
INR appreciation would erode this RBI capital. The report itself says that such
substantial INR appreciation will be prevented by RBI as the central bank can
print unlimited amount of money to buy excess FX flowing into the country. To
put it into perspective a 1% appreciation in INR erodes RBI capital by Rs. 24 k
crores. Such depletion of RBI’s capital would also immediately reduce RBI’s
ability to pay dividend to the government and therefore negatively affect the
fiscal math of the government. If the government would not have argued to
use this capital, then it could have been ignored as a notional value, but
since the government seems to be keen to unlock value from the same, it becomes
important to keep an eye on this account. On 30-6-2016 USDINR had closed at
67.52 and for RBI to record gains on 70% of its assets (which is the country’s
FX reserves), USDINR needs to be higher than 67.52 on 30-6-2017. This argument
therefore rules out any substantial INR appreciation for the medium term while
indicating towards a moderate pace of depreciation.
-
Immediately, INR seems to be on an appreciating
trajectory as EM currencies and equity markets globally support risk assets.
March generally has been one of the best month’s for INR and the reason could
be bunched up inflows before the end of the financial year end.
Fundamental view
Immediately from the current levels of 66.85, half to one
percent appreciation is possible in INR if risk supports globally. The short
term, short USDINR view will get stopped out with a 67.20 or higher close on a
weekly basis. In the medium term of 3-6 months, we should see mild INR
depreciation. Mild INR depreciation would mean, depreciation lesser than the
forward premium unless one catches the bottom; Therefore making import seagulls
as a better option to hedge, than forwards, on an ongoing basis. In case of EU
political risks raising its head, we might see USDINR headed towards previous
highs of 68.85.
Technical
Immediately INR seems to be on a strong footing but
appreciation should be limited to 66.50 or at best 66.10. Given the above
factors I would expect USDINR to bounce from those levels towards 67.50-68.00
by June 2017.
View
Current levels – 66.85.
March 2017 end – 66.50, stop would be above 67.20 weekly
close.
June 2017 end – 67.75. I would enter this trade at two
levels of 66.65 and 66.25 with stops of 66.45 and 65.95 respectively (weekly
close).
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