Rupee slips but experts say no large depreciation likely
The rupee’s vulnerability came to the fore after the US Federal Reserve invoked its second rate hike of 2017 despite inflation running well below the target. The rupee on Thursday slipped 24 paise to close at 64.53 levels against the dollar. However despite the relatively hawkish US Fed, the US Dollar is unlikely to firm significantly, implying no large depreciation bias for the Rupee said forex experts.
As widely expected, the US Federal Reserve increased its policy rate by 25 bps to a range of 1 to 1.25 per cent in its monetary policy meeting that concluded late on Wednesday. The US Fed also announced its balance sheet normalisation (the first move to wind down quantitative easing) plan to gradually start selling its bond holdings later this year which is likely to arrest the sharp currency appreciation of emerging market currencies.
This is the Fed’s third rate hike since December and signals that the US economy is getting stronger. The Fed has increased its benchmark interest rate by a full percentage point over the last two years, after leaving the rate close to zero from late 2008 to late 2015.The new range will be one per cent to 1.25 per cent for a rate that currently is 0.91 per cent. There are indications that there would be one more rate hike during the course of 2017.
The Fed has increased its GDP forecast for the year to 2.2 per cent while unemployment is expected to decline to 4.3 per cent by the end of the year. Second, the Fed has announced that it will unwind its $ 4.5 trillion balance sheet, or portfolio of bonds including Treasury bills and MBS which was picked up during the QE phases. A limit may be set every month where it will lower their level of reinvestments (actual purchases stopped in 2014 but all the investments were rolled over on maturity to retain its holdings of such securities).

According to the Fed’s proposed calendar, it would initially shed $10 billion a month for three months, divided 60-40 between treasuries and mortgage bonds. It will then raise the pace by $10 billion every three months, maintaining the same division, until reaching $50 billion a month.
The dollar inched with expectations of another Federal Reserve rate hike this year kept alive by a policy meeting. The domestic unit opened up by 4 paise at 64.26 at the Interbank Foreign Exchange market. On Wednesday, the rupee had gained 3 paise to end at 64.30 against the US dollar on persistent selling of the American currency by exporters and also helped by a cooling inflation.
“The Fed intends to use both these measures to raise borrowing costs for businesses and consumers after almost a decade of low interest rates and easy liquidity policy,” said Madan Sabnavis, chief economist at Care Ratings.
“The rupee has moved in tandem with other emerging market currencies. There are two factors — fundamental and technical that is driving the rupee. The inflation differential between India and the advanced economies has fallen, there is domestic stability and we are witnessing strong fund inflows and a weakening dollar which have been the driving factors for the rupee strengthening. We expect the rupee to stay at the current level till the year end with a modest downward bias,” said Soumyajit Niyogi, associate director, core analytical group at India Ratings and Research.

Even if the Fed hikes again in December, the rate differential with the US Fed will remain a comfortable 5 per cent. So far in 2017, the Foreign Portfolio Investors have invested Rs 49,374.79 crore in Indian equities, most of it coming since mid- March 2017 after the five state assembly elections along with Rs 83,874.32 crore FPI inflow in debt instruments which is also strengthening the Indian currency.
India’s macro-economic fundamentals have undergone sharp corrections from the twin-deficit conditions of 2013, forex assets are higher and inflation remains in check. With India yields moving lower, any rise in US yields can weaken flows into the domestic markets to an extent but is unlikely to lead to any immediate reversal said Indranil Pan, Chief Economist, IDFC Bank.
“Consequently, we think that in the current atmosphere, RBI’s monetary policy setting is unlikely to put any significant weight on the US monetary policy. Despite the relatively hawkish US Fed, USD is unlikely to firm significantly, implying no large depreciation bias for the rupee. The 10-year yield in India near term would be tilted towards expectations on RBI’s policy setting and is expected to stay in a range of 6.40-6.60 per cent in the near term,” added Pan.
Falaknaaz Syed