Indian rupee vs US dollar: Don't get carried away by CAD data

Mumbai | Updated: Mar 7 2014, 16:13pm hrs
RupeeA sharp and broad based rally in the domestic equity markets and debt markets. Reuters
A sharp and broad based rally in the domestic equity markets and debt markets, triggered a 1% gain for the Indian rupee against the US dollar. Offshore traders continue to lead the bull charge, as rupee trades at a premium over there. On a one-month basis, the offshore US dollar - Indian rupee forward premia quoted 30/35 paise compared with 52/54 paise for onshore forwards, a clear indication of the speculative flows in USD/INR.

Overnight, US economic data was poor as ISM service sector survey came in much weaker than expectation and also the private sector employment survey from ADP was also weaker. A weaker economic data offered a perfect excuse for the US dollar to be sold against carry currencies. Rupee shut shop around 61.10/11 on spot.

India's current account data from India showed that deficit has contracted to USD 4.2 billion, lowest level in eight years. However, one must not get too carried away by sharply lower CAD, as the quality of a statistic is equally important as is the quantity. A sharp slowdown in the economy along with temporary clampdown on bullion imports, leading to diversion of some quantity to unofficial channels, are the primary drivers of contraction in CAD. Since, the first half FY14, export growth has slowed from double digits to now around 4-5%. Therefore, post election, when economic growth picks up, we can see a sizeable up tick in imports, from oil to gold to rest of the pack. Therefore, questions can be raised about the sustainability of the same. Hence, for a more sustained improvement in CAD, the economic constraints need to addressed.

The question that comes to mind is can then rupee appreciate beyond 60.80/61.00 over the next couple of months. With national elections a month away, there is a binary risk over the horizon for the local unit. Incase, the mandate is decisive then Indian Rupee can enter a phase of sustainable appreciation. As inflows in the real economy in form of FDI and in the financial assets, in form of FII and QFI investments, can become a major catalyst for a strong Rupee. However, at the same time, we have to accept the fact, that when liquidity is strong and speculative bets become stacked on one side, then trends can occur, which some times do take prices beyond rational logic. Therefore, incase, the risk on rally continues in domestic asset markets, Rupee can look to trade beyond the 60.70/90 barrier and look towards 60.00 handle. However, one has to be fleet footed now, while trading the Rupee, as shifts in risk appetite can short circuit trends.

Anindya Banerjee, analyst, Kotak Securities