The rupee breached the 76 to the dollar for the first time since June 2020 due to mounting fears that the US Federal Open Market Committee may go in for faster wind-down of bond purchases and shift to higher interest rates to control rising inflation.

India’s rising trade deficit and the greenback gaining strength against most global currencies also led to traders squaring off their existing bets on the Indian currency.

The US Federal Open Market Committee is scheduled to announce its monetary policy statement after Indian trading hours on Wednesday. The US Fed had earlier indicated the possibility of an accelerated taper of bond purchases in December. Traders are also expecting at least two to three interest rate hikes in 2022 given that inflation in the US is currently at a near-four-decade high. This is leading to outflow of dollars from emerging market economies (EME), including India. Foreign portfolio investors have pulled out funds worth close to ₹1-lakh crore from Indian debt and equity since October.

On Wednesday, the rupee closed 44 paise down at 76.32 to the dollar vs the previous close of 75.88. The relentless selling by foreign investors also dragged down bellwether BSE Sensex by about 1,000 points in the last three trading sessions.

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WHO’s warning on Omicron

Market players are also spooked by the World Health Organization’s warning that Omicron is spreading at a rate not seen with previous strains. This is being seen as negative for EME currencies as it will affect their recovery.

India also reported a record high trade deficit for November at $22.9 billion as export growth slowed. Madan Sabnavis, Chief Economist, CARE Ratings, observed that when there is a wider trade deficit and capital flows are weak, it results in some outflow of dollars which weakens the rupee.

“Almost $59-billion forex has been added since March though there has been an outflow in the last week. Add to this the fact that the dollar is strengthening given the growth impulse as also the expectation of withdrawal of quantitative easing by the Fed combined with increasing of interest rates, the rupee faces a double whammy,” he said.

Sabnavis noted that the market is also expecting rates to be increased by the RBI based on the macroeconomic conditions and a weaker rupee is also reflective of this sentiment given that inflation is high.

“Growth has been stated by the RBI to be steady though not of the durable variety which is another factor working in keeping the rupee weak.

“These factors are now embedded in the exchange rate which is getting corrected and is also reflective of an overvalued currency based on the REER (Real Effective Exchange Rate) theory,” he opined.

Other factors

The chief dealer with a private sector bank said, “In the Indian context, there are no IPOs as of now. FPIs are moving out some money. There are no fresh inflows. Our trade deficit has increased in November. If Omicron cases increase in India, it will impact recovery. So, these factors are weighing down the rupee. Banks bought dollars today. This could possibly be on behalf of FPIs and for defence related payments.”

“If, due to the Omicron threat, the Fed turns a little bit less hawkish than what the market has discounted, the rupee may appreciate. Otherwise, the rupee may depreciate. If the Fed turns really hawkish, rupee may go down to 76.50/52,” said a dealer with a PSB.

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