Will the Indian Rupee cross the $70 mark for now?

How low could the INR go, is the big question doing the rounds in the market these days? Broadly, 4 factors will drive the rupee weaker and 70/$ may become the new normal. Here is why!

Rates headed down from here…

Estimates wary about how much rates could be cut from here. The consensus seems to be that there could be a 25 bps cut in repo rates in this fiscal and another 100 bps in the next fiscal. That is not good news for the value of the INR. Normally, a hawkish monetary stance is always compatible with a strong currency. With the recent liquidity glut in the banking system, interest rates are headed down; sooner and in quicker time. That will put short-term pressure on the INR versus the $.

FII outflows will put pressure…

FIIs have been selling heavily in the equity and the debt markets. This is not hard to imagine. With the US likely to hike rates in December and Indian rates headed clearly downward, the narrow gap could reduce the attractiveness of Indian debt paper. That explains the selling in Indian bonds. Indian equities are more a story of a reversal of the India consumption theme. FIIs have been betting on the story for a while. With the consumer sector facing a slowdown, most FIIs find the basic premise missing. That will surely impact the INR and weaken it in the short term.

EMs story comes into question…

With Donald Trump becoming the 45th president of the US, the focus has shifted to the big $1 trillion boost to infrastructure that Trump has proposed. That is likely to re-rate US equities positively. Also, bond yields have risen in the US making them a more attractive place to park funds. Most emerging markets were hit by the risk-off trade. The worry is also the strength in the USD with the DXY Index crossing the 101 mark. A strong dollar has already weakened the Yuan. With China’s strong externalities, a weak Yuan could trigger a currency war among emerging markets. EMs like India could bear the brunt of the risk-off flow.

It is finally about the REER…

The real effective exchange rate (REER) is an indicator of whether the currency is overvalued or undervalued. With the INR REER at around 115, the RBI Trade Weighted REER index is already pegging INR at 74.8/$ fair value. So a sharp correction in the INR will be healthy since India is already running an annual trade deficit of $140 billion despite low oil prices. While the RBI may be wary of a sharp fall in the INR, a gradual calibrated move towards the 70/$ mark may be on the cards. That will not only make exports more competitive, but also erode the asset inflation in equities due to the artificially overvalued rupee. That could be the good news!

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