USD/INR has gained since the August 2013 to March 2014 reversal from 68.85 to 58.33. Although the sharp fall in Rupee from May 2013 high of 53.66 to 68.85 was triggered by external cues (shift of FED into QE unwind mode & into hawkish monetary guidance) which can be termed as one-off, domestic structural woes from large Current Account Deficit, high dependency on hot-money $ inflows and RBI's weak position to defend (and protect) Rupee in the event of sudden shocks (and resultant one-way excessive fall) are seen as high long term risk on the Rupee. Combination of these factors put RBI in an awkward position to retain high interest rate differential till inflation risks are out of the way. All taken the vicious cycle (and conflicts) between growth-inflation and interest rate-Rupee exchange rate is tough to be broken to aspire for permanent long term relief for Rupee.
What is the way forward? It is possible that USD/INR has already shifted its long term base at 60.20-60.70 adjusting to inflation-interest rate differential to maintain REER favourable to exports and inflows. The permanent solution for the system is obviously to turn surplus in trade/current accounts or to fund the deficit through long term FDI flows and to ring-fence Rupee exchange rate from sudden (and lumpy) exit of FII hot-money, fair-weather inflows. The CAD management strategy should revolve around reducing non-essential import consumption, optimisation of imported essential consumption (through domestic production) and boost (and promote) exports. The Government has already started the ball rolling through cuts in subsidy on imported items, higher tax on non-essential imports, energy substitution and "Make-in-India" invitation to foreign manufacturers, benefits from these initiatives will accrue over long term; till then structural woes on the system will remain valid, but with diluted intensity going forward, hopefully!?
What is the Rupee exchange rate outlook? Having lifted long term base to 60.20-60.70, Rupee is at risk of slow (but gradual) weakness into 62.10-62.25 (near term) and 62.85-63.00 (short term), while not ruling out further weakness into/beyond January 2014 low of 63.32 in the event of dollar establishing its strength over global currencies. All taken, major risks on Rupee from external sector are from FED shift into rate hike cycle and reversal in commodity prices, while worry from domestic sector is the execution risk to resolve said structural woes that could impact the optimism on improvement in macroeconomic fundamentals leading to delay in sovereign rating upgrade. For now, strategic long term focus on Rupee is to be tuned at 60.20/60.70-62.85/63.35. The hedging strategy is to stay balanced on risk (and to avoid near/short term carry-trade play) keeping 6M $ range at 63-64 and 12M $ at 65.50-66.50; to stay balanced on risk, it is seen prudent to buy 6M $ around 63-63.25 and sell 12M $ at 66.25-66.50. The hedging strategy should be to avoid monetary loss on the balance sheet without worry on opportunity loss. Given the two-way volatility, it would be a trader's delight to ride the waves around the upward sloping trend line through right entry with tight stop (and reverse, if the correction or extension is seen to go deep); the art of trading the waves is akin to skills of wind-surfing; waiting for start of the right wave to enter, with exit before the next one may pull the rider down! Going forward, there is no major risk of excessive one-way move as RBI is now better placed to guide price-stability and prevent excessive overshoot either-way!
Moses Harding
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