- The operating environment for the INR has improved considerably driven primarily by a more favourable global backdrop.
- However, the INR has underperformed its peer group reflecting investor anxiety about the upcoming general elections that are due to be held over April-May-2019.
- We see some degree of consolidation until the outcome is out of the way. While we are maintaining our trading range of 69.50-72.50 for FY2020, we could revise these forecasts once there is more clarity on the next political configuration.
- Any upward revisions to the USD/INR could take place more on the back of domestic developments turning more adverse than expected.
Pressures have reduced
After the rampant pace of depreciation witnessed over the April-October-2018 period, the operating environment for the INR has improved considerably. The twin pressures points in 2018 of rising US yields and a rampant rise in global crude oil prices have somewhat dwindled. The big game changer has been the re-pricing in the path of US and DM monetary policy over 2019 that has resulted in a relief rally across the EM FX block. The expansionary pivot in the domestic policy environment over the last fortnight in response to evidence of softening domestic growth momentum has also worked as a catalyst in providing some support to the INR at the margin.
Even as global funding conditions have improved, the INR has on balance underperformed its peer group. For that matter, net FPI flows into the domestic markets have been much lower in quantum than compared to other EM economies as a whole. Hence, the INR has emerged as an underperforming EM currency in the process. The INR has even underperformed some of its peer CAD currencies such as the IDR and PHP. We attribute this degree of underperformance to investor uncertainty about the outcome of the general elections and some apprehensions about domestic growth prospects.
Waiting for the resolution of various uncertainties
We see some degree of consolidation up ahead in the USD/INR pair. Global investors are likely to become somewhat circumspect of ramping up positions until the final outcome of the general election is out of the way. Besides, global crude oil prices appear to be bottoming out. The supply cuts by OPEC that were agreed on in December-2018 and possible supply reductions from Venezuela and Iran are starting to filter more prominently into prices. While we are not expecting global crude prices to run away as they did in 2018, we see limited downside possibility with an equilibrium range for Brent crude prices of around USD 60-70/bbl in H12019. The upshot is that the incremental support from crude prices that had become pronounced over November-January is likely to fade limiting an important support that has been in place for the INR and making the currency more vulnerable to capital flows in the process.
The general election outcome is a binary event for the Rupee as it will have a bearing on capital flows depending on the outcome. Investors are likely to be more concerned about policy continuity and certainty going ahead. Till then we could see some consolidation and bouts of spikes in volatility triggered by crude prices or global events such as developments on US-China or US-EU trade negotiations.
We maintain our view of a possible de-escalation in the US-China trade war over 2019 and that the majority of global central banks maintaining an accommodative stance. The pricing in of slowing US growth rate and the Federal Reserve moving to a neutral stance is likely to support EM currencies on balance over 2019. Besides, recent media reports stating that US officials are pressing on Chinese policymakers to ensure that the USD/CNY pair remains more stable as part of truce on trade could mean another important structural support for the EM currencies, particularly the AXJ block. The upshot is that any upward revisions to our USD/INR projections are likely to come from adverse domestic developments. The RBI could also continue to intervene to ensure that volatility remains contained.
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