InvestorQ : Why did the rupee fall so hard on Friday and do you see any recovery in the rupee?
swati Bakhda made post

Why did the rupee fall so hard on Friday and do you see any recovery in the rupee?

Sam Eswaran answered.
2 months ago

If there was one factor driving the weakness in the rupee, it was the Fed decision to hike rates by 75 basis points. In addition, the Fed also committed to stay hawkish and keep raising rates till the time the inflation did not come down perceptibly. Once the Fed rate hike was announced, INR weakened well beyond 80/$ and by Friday, it had settled well beyond 81/$. It now looks like the USDINR could trade in the range of 80-82/$, although it would depend on whether the RBI chooses to intervene in the currency markets.

But the Fed meeting is just one side of the story. The bigger risk is on the Monetary Policy Committee (MPC) of the RBI which will happen between September 28th and 30th. When the RBI statement is announced on 30th September, RBI is most likely to hike rates between 40 basis points and 50 basis points. The Indian markets are already betting on rates going all the way up to 6.5% or even higher and that could cause a lot of tightness in the economy. But even if the RBI keeps pace with the Fed, the rupee could still face pressure. That is because, Fed is likely to hike another 125 bps between November and December.

If you ask me the real factor determine the rupee, it would be the extent of the RBI intervention to defend the rupee. It depends on whether the RBI would continue to sell spot dollars in the market to anchor rupee fall expectations. This has two side effects. When the RBI sells dollars in the market and absorbs rupee liquidity, it makes liquidity conditions in the market tighter. But, more importantly, we have seen a very sharp erosion in forex reserves from $647 billion down to $545 billion, which limits the hands of RBI to intervene.

Even as the CME Fedwatch (the gauge of rate hike probability based on fed futures trading) is indicating 75 bps in November and another 50 bps in December, there is also the Chinese Yuan risk that is rising. Chinese Yuan weakened to a multi-year low of 7/$. If you remember what happened in the year 2015, when the Chinese Yuan weakens, the rupee falls in conjunction to stay competitive. The Bloomberg Dollar Index or the DXY is already at a 20 year high level of 111.41 and that would hold the key to the future of the rupee.

Finally, there is a very important fundamental factor which we must not ignore at this point. That is the current account deficit, which is a key factor impacting the rupee value and we saw that in ample measure in the year 2013 when CAD went up to 5.5% of GDP. For Q1FY23, the CAD is likely to touch $28.4 billion or 3.4% of GDP; a 9-year record. Incidentally, for the full year FY23, the CAD could get closer to 4.5% to 5% of GDP. That would actually be the real worrying factor for the Indian rupee and mean more pressure.