RBI is losing the battle at preventing rupee appreciation, and the next couple of weeks could see some drama
Looking back, I remember two occasions— one must have been nearly 30 years ago and one more recently—when the rupee moved surprisingly sharply in the last week or ten days of the year. In both cases, of course, the rupee fell, breaking through levels that RBI had been supporting for some time.
In the first case, when the rupee crashed during the last two or three days in the year, I had thought it was possible that the market team was on holiday and there was nobody minding the store—this was pretty long ago and RBI’s processes were nowhere near as tight as they are today. Of course, it could also have been that I was in a holiday mood and assumed everybody else in the world was as well. The second time was more recently, and that time, it was clear that the global market had pushed RBI further than it could sustain.
Today, we may be approaching a similar situation, but in reverse. The accompanying chart appears to show that RBI is losing the battle at preventing rupee appreciation, and the next couple of weeks could see some drama.
It is well known that portfolio flows—in particular, equity flows—have been huge over the last couple of months. While the daily average equity inflows during 2020 (to date) was around $80 million, the daily average since the start of November has been $480 million, six times as much. Of course, as a result equity prices are sky-high (everywhere), but there is still an expectation that, with the vaccine and economies opening up, there could be more to come.
Importantly, since it has become clear that RBI will find it difficult to cut interest rates with inflation looking more and more difficult, and given that the developed economies, at least right now, are still looking at standing pat on rates, there has been a recent rise in debt inflows as well. From an average net outflow of $53 million a day from January to November this year, debt inflows in December have picked up to an average of $90 million a day. This may be a response to the expectation that selected G-Secs may find their way into the global indices, since the frictional issues—KYC, taxation, etc—appear to have been resolved. With most global fund managers resetting their allocations at the start of the year, January could see things really break loose—the highest 7-day average of debt inflows this year was $330 million!
Again, and perhaps most critically, the US government has just put India on the watch list for currency manipulation—the fact that our reserves have risen by $100 billion or so in 2020 has clearly not escaped their notice. This would certainly add to the pressure on RBI to reduce its intervention which, of course, in this environment would see the rupee shooting higher.
The accompanying chart shows that rupee has already crept above a strong resistance line beginning at the start of the year. The next stop is the straight line a few paise below 73, a mere 40 paise away.
After that, look out!
The author is CEO, Mecklai Financial