If US Fed goes for taper-lite, Indian rupee may gain against US dollar

Updated: Jan 30 2014, 03:41am hrs
RupeeIndian Rupee opened stronger, around 62.25/26 on spot and rallied all the way upto 62.10/11.
Volatility ruled supreme as traders absorbed a fast revolving monetary policy environment in the emerging markets. Overnight, Turkish central bank hiked interest rates by 425 bps to 12% to prevent its currency from sliding further against the Euro and the US Dollar. On account of this hike in the rates, a risk-on mood prevailed across Asia, once trading got under way in India. Indian Rupee opened stronger, around 62.25/26 on spot and rallied all the way upto 62.10/11, as speculators offloaded stale longs in US Dollar. However, the going beyond 62.10 got tough, as importers indicated strong appetite for US dollar and offshore markets started quoting a discount on the rupee. The positive spin from Turkey did not last long, and once the EM currencies showed renewed, rupee too retraced all of its gains against the US dollar and closed around 62.40/42 levels on spot. It touched an intra-day low of 62.50/52 on spot.

History is a strong guide of how one after another emerging market has failed to curb foreign exchange volatility, by hiking interest rates. Interest rates are blunt tool and fail to produce any good, rather cause further harm, as chief causes remain un-addressed. Last year, India and Indonesia, both tried to stop depreciation of their currencies and both failed. We fear that, after Turkey's sharp increase in interest rates, there can be case of peer pressure to build on fragile EM nations, like Indonesia, Brazil and South Africa. In such a scenario, if US Fed decides to taper liquidity by USD 10 billion, it can add fuel to the EM contagion. On the other hand, if US Fed decides not to taper or announces a taper-lite, it can be seen as a serious moral hazard and undermine their credibility, but EM currencies can see a few days of gains against the US dollar.

Over the near-term, we continue to expect volatility to remain high, as market digest the outcome of the US FOMC meeting and the EM monetary policies. We are looking for a range of 62.00/62.10 and 63.10/63.40 on spot, with interim resistance around 62.50/55.

By Anindya Banerjee, currency analyst, Kotak Securities

NOTE: The views are those of the author