The INR is up by 6.16% against the USD since December 2016 when it was trading slightly above its all-time low levels of Rs 68.8 (seen in August 2013) against the USD. Both domestic and global factors are playing in favour of the INR, domestically the country is witnessing strong political stability that can lead to faster pace of reforms and improved macros in future. The factors that drove the INR strength include strong macro fundamentals, political stability and global liquidity. Will these factors play out positive in 2018?
BJP’s massive win in the Uttar Pradesh elections, the result of which was declared on 11th March 2017, fuelled a massive stock market rally driven by foreign investors along with surge in inflows into the debt market. In March 2017, INR was trading at 20-months high of Rs 64.28.
The political situation has become stronger in the country as the ruling party at the centre, BJP, won the key Gujrat and U.P. State Election, which was seen as an affirmation of Prime Minister Modi’s policies and positive for capital flows. The ruling Narendra Modi government is expected to regain power in 2019 general elections, leading to low political risk for the economy. India’s strong trade data and Fed on a steady rate hike path point to a surge in capital flows in 2018. INR is in a sweet spot and can potentially stands to gain on these factors. GST that was implemented in July 2017 is a key indirect tax reform and though there are early glitches, the new tax code will raise the tax to GDP ratio. Government’s plan to recapitalise banks with Rs 2.4 trillion of equity infusion removes a key stumbling block for the economy.
In September 2017 Indian Rupee fell to 6-month low at Rs 65.5 levels against the USD. The INR weakness was largely due to concerns that India’s fiscal deficit can widen after the government said it was considering measures to boost growth. The INR fall was temporary given India’s strong macros. Fiscal deficit is targeted at 3.2% of GDP for this fiscal and fx reserves were healthy at USD 402 billion and technically at USD 428 billion with RBI carrying USD 31.17 billion of outstanding forwards. Current account deficit (CAD) at USD 7.2 billion (1.2 per cent of GDP) in Q2 of 2017-18 increased sharply from USD 3.4 billion (0.6 per cent of GDP) in Q2 of 2016 -17 but fell sharply from USD 15.0 billion (2.5 per cent of GDP) in Q1 of 2017-18. The widening of the CAD on yearly basis was primarily on account of a higher trade deficit (USD 32.8 billion) attributed to larger increase in merchandise imports relative to exports, specifically due to higher oil imports.
In November 2017 INR gained against the USD on the back-Moody’s rating upgrade of India, which boosted market sentiments. INR was expected to strengthen more on the back of USD staying volatile though the rating upgrade does help sentiments. Markets expects the government to continue with reforms and thrust on economic growth. Trade data for November 2017 showed a sharp jump of 30.55% export growth indicating both a revival in global trade and improved global economic conditions. Higher export growth, if sustained, raises prospects of a faster growth in GDP as output increases.
In December 2017 Fed in its policy meet raised rates to 1.5% and guided for more rate hikes in 2018 but the pace of hikes will be gradual as its committee members stay cautious on lack of inflation expectations. Read our note on Where the Heck is Inflation?. Asset markets will be enthused by the Fed’s tone on inflation and will drive asset prices higher, which is positive for global capital flows and INR.
FII’s have been strong buyers of equities (USD 8.3 billion) and debt (USD 22.8 billion) in 2017.
RBI has bought a cumulative of USD 17.15 billion in the April-October 2017 period adding around Rs 1 trillion of liquidity into the system. RBI has also built a forward USD position of USD 31 billion, which is around Rs 2.2 trillion of latent liquidity.RBI has been building forward positions to postpone the liquidity impact of its fx operations. RBI will have to manage predently the liquidity arising from capital flows as it purchases USD to prevent a sharp INR appreciation.
India’s external debt to GDP ratio, debt coverage ratio and foreign exchange reserves to external debt ratio as of June 2017 were stable as compared to March 2017 ratios and showed improvement against June 2016 ratios. Stable external debt ratios is positive for capital flows and for INR. India’s external debt as of end June 2017 stood at USD 485.8 billion, an increase of USD 6.2 billion from USD 479.6 billion seen in end June 2016.
In the first half of 2017-18, foreign exchange reserves rose by USD 20.9 billion on strong capital flows despite rise in current account deficit.
On 19th December, the US senate passed the USD 1.5 trillion tax reform bill 51 for and 48 against and on 22nd December President Trump signed the bill and also approved spending bill for US government. USD was under pressure last week as markets are worried about increase in fiscal deficit due to tax cuts and downward revision of Q32017 GDP to 3.2%.
USD Index (DXY), which tracks the movement of the USD against six major currencies, closed lower by 0.47% on a week on week basis and is at a level of 93.49.
U.S. Q32017 GDP final estimates showed that economy expanded 3.2% annual rate against expectation of 3.3%. The quarterly growth was fastest since Q12015 and the first time since 2014 that the U.S. economy has experienced growth of 3% or more for two quarters in a row.
U.S. total durable goods orders rose 1.3% in November against expectation of 2.0%.
U.S. commerce department reported that personal income increased 0.3% against forecast of 0.4% while personal spending rose 0.6% above expectation of 0.5%.
In November, U.S. new home sales unexpectedly jumped 17.5% to 733,000 from 654,000 in October 2017.
U.S. Department of Labour on Thursday reported that the number of individuals filing for initial jobless benefits in the week ended 15th December rose by 20,000 to 245,000 from previous week’s total of 225,000 against the expectations of an increasing of 6,000 to 231,000.
Euro and GBP appreciated by 0.85% and 0.40% respectively against the USD last week. Catalan’s referendum vote had limited impact on Euro.Pro independence parties have absolute majority in Snap regional elections.
Asian currencies were mixed last week against the USD. Australian Dollar rose by 0.90% on strong economic data. New Zealand Dollar appreciated by 0.26%. Japanese Yen depreciated by 0.68% against the USD and depreciated by 1.33% against the Euro. South Korean Won appreciated by 0.89%, Philippines Peso appreciated by 0.64%, Indonesian Rupiah appreciated by 0.10%, Indian Rupee was flat against the USD and depreciated by 0.43% against the Euro, Chinese Yuan appreciated by 0.49%, Malaysian Ringgit depreciated by 0.01% and Thai Baht depreciated by 0.70%.