Home / Markets / Mark To Market /  India’s rupee has few good days left before risks come knocking

The Indian rupee (INR) has been the best performing Asian currency so far in 2021, largely because of the outsized gains made in the current month. A key ingredient for the rupee has been the steady dollar inflow into local equity market. Dollars have been flowing into emerging market economies, thanks to the loose monetary and fiscal policies of the US.

Most Asian currencies have benefitted from the steady inflow of dollars. But what had set apart these currencies was the recovery trajectory of their respective economies. The expectations on economic recovery for India have been far more optimistic compared with other Asian countries. This has meant that global liquidity has been chasing Indian assets much more than other countries.

A 25 March report of Kotak Institutional Equities shows that fund allocations towards India increased by 11% in February. That and the relatively higher interest rate differential with the US has helped the rupee.

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“Much of the opportunity in currency markets lies in picking and choosing within emerging market foreign exchange (EM FX). We like low yielding currencies with high growth potential, including those in North Asia and central and eastern European countries (CEE), as well as certain large, high carry EM economies including India, Mexico and Russia," wrote analysts at Barclays Capital Inc.

Another push factor for the rupee has been the lightening of intervention by the Reserve Bank of India (RBI). The central bank had kept a lid on the exchange rate for most part of 2020 through heavy intervention. But in January, RBI bought just $2.8 billion from the foreign exchange (forex) market compared with $3.9 billion in December and $10.2 billion in November, the RBI data showed. Intervention in the following months is also expected to be minimal.

But there are risks around the corner that may dent sentiment for the rupee. The streak of dollar inflows into equity has slowed slightly because of the concerns over a second wave of covid infections. Fresh infections have surged in India, threatening mobility and recovery again.

A part of the optimism was also on expectations that foreign investors would pick up shares from a flurry of initial public offerings (IPOs). This IPO-related optimism is likely to thin out, said Madhavi Arora, lead economist, Emkay Global Financial Services Ltd.

“We anyway think policymakers are getting more tolerant on a weaker INR in the medium term, and calendar year 2021 will see rupee being in the middle of the emerging market forex pack and not an outlier on either side on spot returns."

The rupee is soon likely to confront risks once the dollar rush slows down. But as long as global liquidity keeps flowing into the equity market, the currency may find enough support to stay strong.

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