By Moses Harding, Head - ALCO and Economic & Market Research, IndusInd Bank
We discussed the need for RBI to think of measures other than intervention to prevent rupee weakness beyond 54. RBI?s intervention (how aggressive it may be) was ineffective in a highly dollar demand driven mode. The earlier measures to open up inflows through FII/ECB/NRI route did not yield desired result. Hence, the need is to explore ways and means to cut the dollar demand from the system and get the market into neutral mode to make RBI?s intervention effective. That?s what has been done now. The demand for dollars is now reduced significantly through blocking export cancellations; corporate speculation through performance based limits (mainly NDF trades) and limiting intraday/overnight exposure of Banks. The market was in heavily over-sold position with exporters covering most of receivables and importers/FC borrowers maintaining large open positions. The chance of exporters to cancel the existing contracts with intention to reinstate at better levels is now blocked; thereby cutting huge demand through export cancellations. RBI?s ineffective intervention resulted in widening arbitrage between off-shore NDF and on-shore OTC; thus generating huge dollar demand in the domestic market. This is also cut now. Other measures such as cutting the exposure limits for Banks are not very significant.
Over all, the huge gap in days? demand-supply is bridged and expected to stay in either neutral mode or shift into supply driven mode; thus bringing the Rupee exchange market in firm control of RBI. While many will advocate that these steps are not fair-play; RBI did not have any other option to arrest spread of currency woes into inflation and the economy. It was the last weapon as RBI cannot go the SNB way (to open up dollar sales counter at predetermined rate). It was discussed in earlier reports that rupee weakness beyond 54 will push the Indian economy into low growth; high inflation mode which would be economic disaster. It would need exchange rate stability at 51-54 till inflation worries are out of the way. Post that and firm downtrend in commodity prices, RBI would allow the rupee to float along with USD strength. Now, RBI can afford to turn into dollar ?buy mode? to release rupees into the system without CRR/OMO route. So, focus is back to the 51-56 short term range play while 54 remains firm in the near term. Rupee fall from 44 to 54 since August 2011 is excessive and it would have been in order if the market had shifted into supply driven mode at 54-56 to provide rupee stability at 51-54. When rupee woes are imported from external sector on which RBI did not have any control; use of these options can be considered as prudent (and sensible) if it could arrest rupee impact on inflation. Let us welcome these moves with pinch of salt for the good of the Indian economy.
Policy expectations:
CRR: UNCHANGED. RBI has now has the option to inject liquidity through OMO purchases in the bond market and dollar purchases in the FX market; hence no need at this stage to cut CRR for the purpose to address tight liquidity above RBI?s comfort level of minus 1% of NDTL.
Repo rate: UNCHANGED. The moderation in growth momentum below 7.5% and headline inflation stubbornly above 9% will keep RBI in pause mode into January 2012 monetary policy review.
Guidance: NEUTRAL. RBI may not choose to sound dovish at this stage. Rupee woes are not completely out of the way. RBI has already exhausted all its options including strictures in FX operations. RBI will look for improvement in the external sector to get the worries on inflation and rupee out of the way before shift into dovish stance.
Currency market: We discussed that rupee weakness beyond 54 can push the economy into low growth; high inflation mode considered as disaster when RBI struggles to balance both growth pressures and inflation worries. Now that RBI has cut the demand, rupee is expected to be in consolidation mode at 51-54 with immediate bias into 52.50-51.50. Given the fact that rupee value around 51 is fairly valued, it makes sense to keep rupee bit undervalued for the benefit of exporters who have paid for these FX strictures losing their freedom to un-do past mistakes. So, providing stability around 52.50 will be in order. RBI would now have the option to operate from ?buy side? to supply rupees into the system. It is important for RBI to keep rupee exchange rate in its grip till inflation eases into 7%. The shift into low growth; low inflation (around 7%) will enable RBI to take dovish stance on monetary policy. We advised exporters to cover 1-3M receivables on extended weakness into 54 with 3M forward dollars looking attractive at 55.00-55.50. We saw a high of 3M dollars at 55.25 to bring in supplies which made RBI intervention effective to drive rupee from low of 54.30 for close below 53.70. We also asked importers to stay away for 53.50-52.50; now importers will get to buy cheaper dollars around 52.50. Having said these, fundamentals continue to remain weak. USD Index is bullish for gradual move into 89 in the short term tracking economic woes in the Euro zone and better economic performance out of the Euro zone. USD Index is expected to form a strong support base around 79.80 and prepare momentum to take out 81. Domestic stock market is also weak tracking growth pressures. Let us now look for consolidation in rupee at 52-53. It is important for importers to hedge on extended reversal below 52 where RBI is expected to get into dollar buy mode. On the other hand, exporters can sell 1-3M dollars on weakness into 53. Over all, 3M forward dollar above 54 will be good for exporters and 12M forward dollar below 54 will be good for importers.
EUR/USD is able to hold its weakness at 1.2950-1.3000 but the bounce from there lacks momentum and has held at 1.3050. Our strategy to exit short EUR/USD positions at 1.3000-1.2950 for bounce into 1.3050/1.3150/1.3250 is valid. We continue to watch consolidation at 1.2850-1.3150 with bias for extension into 2650. Our short term target continues to remain at 1.20-1.18. Strategy is to sell EUR/USD correction into 1.3050-1.3250 for 1000 pip dollar rally into the short term. USD/JPY is in tight consolidation mode at 77.75-78.25. It is matter of time before see extended dollar strength into 79.00-79.50.
FX premium spiked to 7% in 3M and 5% in 12M (higher end of set near term range of 6.0-7.0% in 3M and 4.5-5.0% in 12M) before close at 6.75% and 4.9% respectively. RBI?s sale of forward dollars arrested test/break of higher end. Now, it is important for RBI to allow a bull run in FX premium to shift forward market into supply driven mode; leading exporters? supplies and lagging importers? demand. We will revise the near term range into 6.5-7.5% in 3M and 4.5-5.5% in 12M with bias into the lower end. This will also help release of dollar credit to exporters at affordable cost. RBI may need to keep FX premium high through purchase of forward dollars to arrest excessive reversal in spot rupee below 52.
Bond/OIS market: The initial gains in the market tracking lower US Treasury yields could not sustain getting the focus back into domestic cues. The initial rally found strong support at 8.45% (10Y bond); 7.75% (1Y OIS) and 7% (5Y OIS) before close at 8.49%; 7.79% and 7.10% respectively. RBI?s actions in the FX market will provide great relief. The fear is of RBI extending its pause mode in monetary policy on shift of currency woes into inflation; growth and fiscal deficit. This relief will provide kind of stability in Bond/OIS market. Let us look for consolidation at 8.40-8.55% (10Y bond); 7.65-7.80% (1Y OIS) and 6.95-7.15% (5Y OIS). The strategy is to play end-to-end as test/break either-way is not expected to sustain.
Commodity market: Gold found support above 1560 (low of 1564) held at upper end of set 1500-1600 range (high at 1593). There is no change in expectation of extended weakness below 1560 for 1520-1500. In the meanwhile NYMEX crude failed close to higher end of set near term range of 90-97 for move below 95 and looks good for extension into 90. Let us now watch 90-95 with bias into the lower end.
NIFTY: The initial weakness in NIFTY held at the immediate support at 4675 (low of 4673) for decent bounce into 4773 before close at 4746. RBI?s actions in the FX market will provide bit of relief to domestic stock market to provide consolidation at 4675-4825 with overshoot limited to 4650-4850.
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