Here’s why analysts believe Fed rate moves may no longer hold rupee to ransom

The theatre in which the Fed’s actions are seen exerting the most immediate impact back home is the exchange rate, but experts on the Indian rupee feel that there are factors which could provide a fair degree of cushioning to the domestic currency.

As it stands, the rupee has shown a fair degree of resilience so far in the Fed’s latest round of monetary policy tightening.

With inflation in the US running at forty-year highs, the Fed has made it clear that it will act swiftly on interest rates and the trimming of its balance sheet, the massive expansion of which during the pandemic flooded global markets with liquidity.

The US central bank hiked benchmark interest rates in March by 25 basis points, the first rate increase in four years. It is expected to carry out multiple rate hikes of 50 basis points each in the coming months.

Even as the Fed’s rate lift-off has narrowed the interest rate differential between India and the US and consequently sparked heavy sales of domestic equities by foreign institutional investors, the rupee has not suffered a free-fall.

Higher US interest rates typically lead to global capital flowing out of emerging markets to the world’s largest economy.

“Fed hike by 50 bps and provides no guidance on the Quantitative Tightening, then US DXY could remain in 103.20-103.90 range. If they hike by 50 bps and guidance on the QT and provide schedule of bond sale, then US DXY could rise towards 104.20-40. The probability of this case is almost 50%,” CR Forex Advisors Managing Director Amit Pabari said.

The US dollar index, which measures the greenback against six major rival currencies, has strengthened 8 per cent so far in 2022.

Over the same period, the rupee has depreciated around 2.8 per cent versus the US dollar, against 3.2 per cent depreciation in the Thai Baht and the Chinese Yuan. The Malaysian Ringgit and the South Korean Won have fared worse, losing 4.3 and 6.2 per cent against the US dollar, respectively.

In contrast, when the infamous ‘taper tantrum’ happened in 2013, the mere mention of the Fed shrinking its balance sheet resulted in the rupee losing a massive 15 per cent versus the dollar from May to August of that year.

FLOW FACTOR, RBI RESERVE MUSCLE

While the Fed’s statement will likely cause immediately cause volatility in the exchange rate, experts feel that unless the US central bank adopts “an extreme form of hawkishness”, the domestic currency may not suffer too much.

“We are sitting on a knife-edge; if the (Fed) commentary or the press conference is a little more hawkish than the markets anticipate – the extreme form of hawkishness would be to take the Fed fund’s rate to 3.25 per cent by the end of the year which is the neutral rate – then things could just go belly up,” HDFC Bank’s Chief Economist Abheek Barua said.

“But, if it is seen either in line with expectation, or a little softer than expectation, then we could see the flows sustaining and perhaps even accelerating for a period. We were looking at – because of the LIC-related flows – we were broadly looking at between 75.75/$1 to 76.25/$1,” he said.

The rupee was last at 76.44/$1.

The expected flows that would hit the market on account of companies looking to invest in the Rs 20,557 crore Initial Public Offering of LIC are indeed a key factor supporting the rupee. The IPO, the largest ever in Indian markets, is open from May 4 to May 9.

Even as the surge in crude oil prices following the Ukraine war puts pressure on the domestic import bill while fears of a growth slowdown in China cast a damper on global growth prospects, analysts believe that India holds sway as an investment destination.

“The flow story completely outweighs negative global sentiments… All focus will be on India’s biggest IPO- LIC, which opened today,” Pabari said.

“The anchor book worth Rs 5,627 crore got an overwhelming response. There could be a steady inflow on account of the same and could be a point for Rupee’s appreciation. That apart, MSCI rebalancing a few stocks could attract yard ($1 billion) of flows.”

Another factor that provides a stronger footing for the rupee is the RBI’s large arsenal of foreign exchange reserves, currently just above $600 billion.

Unlike the taper tantrum episode, during which speculators were emboldened to place bets against a beleaguered rupee, in the current scheme of things, the RBI’s FX warchest provides considerable protection.

The central bank has in fact, made its intention to prevent excessive volatility in the rupee clear by significantly selling dollars from its reserves in the face of global headwinds.

RBI data shows that as on April 22, the central bank’s foreign exchange reserves stood at $600.42 billion as against $631.5 billion on February 25.