Sluggish FPI inflow, firming dollar index, rising crude, higher inflation to take toll on the currency
While the rupee started FY2020-21 at 75.66 to the dollar, it finally closed 3.3 per cent higher, at 73.18. The weaker dollar index was a major factor that supported the strengthening rupee, as it depreciated by 5.8 per cent, weakened by lower interest rates and the larger fiscal stimulus.
Another factor keeping the rupee buoyant was higher foreign capital inflows. Indian equity and debt markets received over Rs 2.67 lakh crore from foreign portfolio investors (FPIs) in FY2020-21. This was the highest flow to any major emerging market during that period and greater than the cumulative inflows of the last six years. FPI inflows increased mainly due to weakness in the dollar index and the unrelenting rise in the Nifty, which climbed 71 per cent, delivering its highest returns in the past 10 years.
The rupee’s appreciation against the dollar in FY2020-21 was also supported by higher tax collections by the NDA government. Excise duty imposed on petrol and diesel by the Centre is a major tool that catalyses the rise in fuel prices and the government has doubled the excise duty on petrol and diesel over the last two years.
With all these inflows, the country’s foreign exchange reserves surpassed Russia’s, making India the world’s fourth largest reserve holder in the world, after China, Japan and Switzerland. Indian foreign exchange reserves touched a record high of $590.18 billion in the week ended January 29, leaving the RBI with reserves and room to support any fall in the currency.
But looking ahead, we expect the rupee to depreciate against the dollar in FY2021-22. Now, let’s look at some of the major factors that could trigger this downward pressure.
FPI inflows are likely to slow down: Over the past few weeks, FPIs reduced their activity and withdrew money from equity markets mainly due to higher bond yields and the rising dollar index. Going forward, any further increase in FPI outflows from domestic markets will put downside pressure on the rupee.
Dollar index may appreciate in FY2021-22: Over the past two months, the dollar index strengthened by 2.9 per cent due to higher bond yields and a rebound in the global economy. Any further increase in the dollar index will send the rupee southwards.
Crude oil prices rising: Over the past month, crude oil (Indian basket) was trading above $64 a barrel. As India imports more than 80 per cent of its crude oil requirements, a significant price change in crude oil has a direct effect on India’s current account deficit. Rising crude oil prices could increase India’s inflation and import bills as well. That could, in turn, widen the country’s trade and current account deficits and devalue the rupee.
Forex reserves decreasing: Over the past two months, India’s forex reserves declined by $10.9 billion to reach $579.285 billion, according to an RBI report published on April 2. This decline has been mainly due to the appreciating dollar and higher crude oil prices. Moving forward, the RBI will have to dip into its reserves to stabilise the rupee.
Higher inflation to hurt the rupee: For FY2021-22, we expect the inflation rate to increase, mainly due to an increase in the prices of energy, base metals and agri commodities. Commodity prices have been surging due to lower interest rates, global stimulus packages and various liquidity measures taken by global central banks. Any further surge in commodity prices will increase inflation and that could put pressure on the rupee in the days to come.
Technical outlook for the rupee
Technically, the USD/INR has formed a descending triangle pattern on the daily charts and we expect the price to face resistance at both the trend line and the 200-day moving average, which comes around 73.70 levels on a daily closing basis.
According to this pattern, if the price breaks out above the trend, it can head towards target levels of 76.30 to 76.50 over the next two to three months. On the downside, 72.20 will provide strong support in the short to medium term period.
Second Covid-19 Wave
Over the past few days, the rupee depreciated against the dollar mainly due to fear of another lockdown, which will slow down the economic recovery. However, it is expected that the government will reintroduce multiple restrictions to tackle the steady increase in Covid-19 cases across the country (no full lockdown). Any further increase in cases and lockdown may put pressure on the rupee in the coming days.
The author is Head-Commodities, Ventura Securities Ltd
DISCLAIMER: Views expressed are the authors' own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.