One year before the union elections the policy makers would want to ensure that panic does not set in the economy. A possible cause for the panic could be INR depreciating beyond 68.90 or 10 y going above 8%. To avoid this a BJP victory in Karnataka could be the catalyst for the central banks to sell USDINR more aggressively and bring it lower.
How does this fit in the RBI's monetary policy objective? If anything the RBI is worried about inflation going higher in 2018. The BJP would not like to make the mistake of UPA which allowed inflation to go out of control and subsequently got voted out. Therefore it would make sense for the RBI to use such opportunities to sell USDINR (or at least allow INR appreciation) and give the absorbed liquidity back to the system through OMO purchases, thereby controlling yields also.
Dollar strength or weakness always plays a pivotal role in deciding where INR goes. Dollar index has failed to give a close above 92.57 levels in the last 2 weeks perhaps indicating that the correction up is over. Complimenting this EURUSD failed to close below 1.1936 in spite of making a low of 1.1820. Therefore the current dollar weakness will also support INR appreciation in the short term if the election results fall in place for the incumbent central government. Other EM currencies have also appreciated more that INR in the last couple of days and my comparable index shows INR at 66.75 according to current EM currency levels. For the day CMP 67.25, Range 67.31-67.11.
Caveat: this view is tactical only as the current account pressure on INR does not change because of the election results neither would FIIs start putting money into India. At most the FII outflows might decrease for the time being.
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