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#39;Ratings downgrade induced weakness is an ideal opportunity to sell dollars#39;

June 03
13:08 2020

Devarsh Vakil

Exchange rates play a vital role in a country’s level of trade, which is critical to every free market economy in the world today. The theory talks about the effect of interest rates on the exchange rate mechanism, though the relationship between politics and exchange rate has grown stronger in an era of quantitative easing. The Indian rupee, which was on a par with the American currency at the time of Independence in 1947, has depreciated by a little more than 75 times against the greenback in the past 73 years.

RBI announced a unscheduled repo cut of 40 basis points to 4 percent, the lowest level in two decade, while maintaining an accommodative stance in an unscheduled meeting on May 22.

Rupee had been trading stronger on back of strong flows into our country and return of ‘risk on’ sentiments in equity markets around the world. For the month of May, foreign institutions bought $ 1.56 billion worth of equities and sold $ 2.73 billion bonds.

The rupee would have appreciated to a much higher level had it not been incessant buying from the central bank. India’s forex reserves hit new record high to $ 490 billion and added $ 10.6 billion dollar during the month.

Government and central banks are working in tandem to soften the blow to economy due to coronavirus pandemic. The rally in riskier assets is amply supported easy monitory policies.

Do not be surprised to see negative policy rates in US sometime this year. In fact, US Fed interest rate futures started pricing negative interest rates. Fed balance sheet is already touching unprecedented $ 7 trillion and on top of that negative policy rates will have profound impact on US dollar. Negative interest rates would be positive stocks and bonds and hurt sentiments on dollar index. The escalation of US – China trade tensions are back in focus as president Trump blames China for the spread of virus.

India’s fiscal deficit for FY20 widened to 4.59 percent of the gross domestic product (GDP) overshooting government target of 3.8 percent by nearly 80 basis points. This is an area of concern as the deficit in FY21 will be even more given the poor revenue collections and extra spend to revive the economic growth.

The Q4FY20 GDP number came in better-than-expected at 3.1 percent (an 11-year low) though the downward revision in the previous three quarters takes away some of that relief. The poor data on growth of India’s eight infrastructure sectors contracting by a record 38.1 percent in April led by cement, steel, electricity and coal was partly on expected lines. However this data does not portend well for Q1FY21 unless we see a fast and complete lifting of lockout with safeguards in place.

Lockdown in India has been extended to June 30 albeit with a lot of relaxations in non-containment zones. This could bring in some positivity in equity markets and may bring in more flows.

Forex market will take cues from recovery in domestic economic activities and any escalation in geo-political front. RBI will continue to intervene in markets to restrict unwarranted volatility. For the month June, we expect rupee to strengthen on the back of continued foreign flows, lower current account deficit on back of lower crude oil prices, weaker dollar on expectation negative interest rates in US.

Downgrade of India’s rating by foreign rating agencies may weaken a rupee a little in the short run but that would an ideal opportunity to sell dollars. 76.2 should be the short term roof while do not be surprised if you see dollar below 75 levels in the month of June. Exporters are advised the hedge their inflows, while importers may book dollars only as per their immediate needs for next few weeks.

The author is Head of Advisory at HDFC Securities.

Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.

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