With no last minute surprises, Fed Chair Janet Yellen’s 25-bps rate hike is definitely a Christmas gift for the financial markets.
Yellen stated in her press conference that the Fed did not want to tighten policy absurdly and cause damage to the current situation.
She also added that the capital outflow from the emerging economies as the US hikes rate is a negative but at the same time the strengthening US economy, which has pushed the Fed to begin its rate hike cycle, is a positive for the emerging economies. From this, the intention is very clear; the Fed does not want another bout of heavy sell-off in the global markets like the one witnessed when the tapering of the quantitative easing was announced in May 2013.
The Federal Reserve’s aim to keep the global markets well-informed with its rate hike proceedings has helped immensely.
That is evident from the market reaction on Thursday. The rupee has continued to strengthen signalling that it is going to trade stable and is not going to repeat the kind of fall witnessed during the QE taper tantrum. Though the rupee has been declining from the levels of 61 at the beginning of this year to 67 levels last week, the fall has been minimal when compared to its other emerging market peers. While the Indonesian rupiah, the Russian rouble, South African rand and the Brazilian real have plummeted between 11 and 31 per cent against the dollar, the rupee has fallen just 5 per cent against the greenback.
This is in spite of a sharp 11 per cent rally in the dollar index witnessed this year. A couple of factors given below suggest that the rupee could continue to remain on the safer side and outperform its peers in case of any volatility.
RBI may intervene First, the strong forex reserves of $352 billion built up by the Reserve Bank of India could help it intervene in case of any unexpected volatility in the market. According to a report by the Bank of America-Merrill Lynch, the RBI has the room to sell $20 billion from its reverses in the event of any sharp selloff in emerging markets and still maintain an eight-month import cover. The RBI also seems to be prepared to intervene as and when required. In a circular last week, the RBI said that it will also start using the exchange-traded currency derivatives segment also to intervene in order to control the excess volatility in the market.
Secondly, the limited selloff in the Indian debt segment by foreign portfolio investors (FPIs) unlike the equity segment has helped in slowing down the pace of fall in the currency. The FPIs have sold a lesser amount of about $900 million in debt compared to the $1.9 billion outflows seen in the equity segment from November till date. Revival in equities could attract fresh inflows in the coming month, which will support the currency further.
Domestic concerns Although the above mentioned factors can help curb excess volatility in case of a sharp fall in the Indian rupee, there are a few domestic concerns that could limit the upside in the rupee and continue to keep it under pressure. While the fall in oil prices has brought down the import bill sharply, India’s export falling for the last 12 consecutive months is a big worry. Also, the manufacturing PMI for November at a two-year low of 50.3 is increasing the danger of the manufacturing activity entering into the contraction zone. The RBI’s closely-watched consumer price index (CPI) inflation has turned higher in the last two months, thereby reducing the possibility of more rate cuts by the apex bank.
So, given all these, where is the rupee headed from here? The sharp reversal in the rupee that had begun this week from the low of 67.13 has the possibility of extending higher to 65 in the short term. But the weak domestic macro numbers would continue to remain a worry, keeping the upside capped for the currency over the medium term.