INR Update: Appreciation could continue as dollar weakens and RBI allows INR gains

Wishing all of you a Happy and Prosperous 2018!

 

Most of the market expects 2018 to be a higher growth year for the global economy. Fiscal deficits in the US are likely to go up and therefore yields are expected to gradually edge higher. On the back of the increasing US fiscal deficit and the US desire for a weaker currency, dollar is expected to trend lower during the year. In longer periods USD shows a strong correlation to US fiscal deficit. Interest rate differential theme is unlikely to work as it has not been for the last 6 months. On the other hand the pricing of an unwind of central bank balance sheet in EU and Japan is ongoing while US monetary policy normalization is already priced in, therefore in spite of increasing interest rate differential we might not see USD gains.

 

In USDINR, the USD part is more important than INR. Therefore in a global USD weakness move, unless there is a panic situation in India, the domestic issues are unlikely to override what is happening with other EM currencies as a basket. The increase in fiscal deficit in India (expected @3.5% from earlier budgeted 3.2% for FY18) has been cautiously executed. The government till now has shown prudence and therefore I would not expect the higher fiscal story to affect any other asset classes except bonds. Inflation is expected to hover at a healthy rate of 4-5% and therefore is unlikely to make INR an outlier in the EM basket in a pro growth environment.

 

India is likely to get highlighted in the US currency manipulator report in Apr 2018 and would be put on the watch list for potential countries indulging in currency manipulation. Perhaps as a counter to this the Indian authorities would now want to match INR appreciation to other EM currencies and ensure that INR does not continue to be an outlier. Therefore given the kind of appreciation we have seen in KRW and CNH I would expect INR to continue its appreciation in January 2018. January is typically also a month when we see fresh equity portfolio allocation flows and this year (FY18) equity inflows into India is only at USD 2 bn till date, therefore there is room for fresh flows to hit in.

 

USDINR 1m NDF is trading 5p left as compared to 7p left yesterday, showing slight decrease in offshore selling pressure. KRW and CNH have depreciated 0.4% and 0.1% respectively since yesterday. USDINR traded at 63.37 overnight in the offshore market. Therefore KRW and CNH explain the higher opening in USDINR today. Asian equities continue to be moderately in the green today. Yesterday in the second half we did not see substantial bids from Nationalised banks indicating that there is intent to allow INR appreciation. CMP 63.56, Range 63.60-63.40.

 

I would expect 62.75 to be seen in January 2018, while February 2018 could price in some risk on account of local budget and Italy elections globally, while in March we can see INR appreciation again.