Tracing the INR trajectory - ICICI Bank : Treasury Research

- The initial bout in Rupee weakness came against the backdrop of Dollar strength as Fed tapering expectation gained traction

- Subsequently, idiosyncratic factors such as increased gold imports (during May) and FII led portfolio outflows led to further pressure on the Rupee

- Sentiment worsened given market concern regarding India's vulnerable external situation on account of financing the CAD.

- Policy makers are concerned about volatility in the Rupee. We believe that sustained FX stability can be achieved through a.) encouraging stable capital flows and b.) reducing the current account deficit in the medium to long term.

Reasons for the Rupee sell off

The sell off in the Rupee came against the backdrop of following factors a.) Dollar factor b.) Idiosyncratic factors including gold imports.) FII outflows and d.) Sentiment

Factoring in just the Dollar move

Superimposing the Dollar move on USDINR cross suggests that "just" on Dollar movement, Rupee should have been at 54.0 levels

Local factors explains the majority of INR moves

Within the idiosyncratic factors, it should be noted that India's vulnerable external situation with an elevated current account deficit weighed on the Rupee. The sharp surge in gold imports during the month of May added to external vulnerability.

Record FII outflow key to Rupee weakness

In the recent months, the better than expected economic data from the US has raised expectations regarding Fed QE tapering program. This has caused jitters in the global financial markets and resulted in capital outflows from EM economies including Indian markets. India has witnessed capital outflows to the tune of USD10.7bn since May 22nd

Sentiment aggravated on weaker growth prospects and external vulnerability

The subdued growth prospects have further worsened the already negative sentiment. The recent set of liquidity tightening measures taken by the RBI to address the FX market volatility is also likely to have negative impact on overall growth prospects.

Financing the CAD through stable source of capital flows is a key challenge

The external vulnerability has worsened in the last few years, in light of the rising current account deficit. In the recent years i.e. 2010 onwards, reliance on portfolio related flows have a key role in financing the CAD.

What will bring stability to Indian Rupee?

Indicators such as a.) One month implied volatility and b.) Elasticity of USDINR to DXY moves suggest that Rupee volatility is at multi year highs.

We believe that sustained FX stability can be achieved through a.) Encouraging stable capital flows and b.) Reducing the current account deficit.

Source : Equity Bulls

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