Currency call. Rupee rally faces strong hurdle at 58

It is celebration time in the currency market. The much-awaited election results are finally out, with the BJP winning by a large majority. As widely expected, Narendra Modi is all set to take over as the next Prime Minister of the country. Stock markets surged to new highs, with the Sensex testing 25,000 levels and the Indian rupee strengthening to a 11-month high on Friday.

The Indian rupee remained strong all through the week. It strengthened from 60.11 on Monday to a high of 58.62 on Friday before closing at 58.78, up by 2.1 per cent for the week.

Let us take a look at the key challenges that the new government will have to address in order to bring about a revival in economy and what the BJP has mentioned in their manifesto to tackle the same.

Measures like gold import curbs and spending cuts by the outgoing government have helped in bringing down the current account and fiscal deficit. The BJP in its manifesto has mentioned that the CAD will be brought down aggressively by focusing on exports and reducing the dependency on imports. But the party’s indication that it would review the curbs on gold imports after coming to power would be a major threat for the CAD. On the fiscal deficit front, it has committed to strictly implementing fiscal discipline without compromising on the funds available for development and asset creation.

The forecast for a below normal monsoon due to El Nino formation this year is a major threat from the perspective of inflation this year. So it will be interesting to see whether measures like setting up a price stabilisation fund, restricting black markets, etc, mentioned by the BJP would help in limiting price rise.

The slowdown in the Indian manufacturing sector is a concern. A revival in this sector could boost growth. The BJP’s manifesto prescribes giving high priority to growth in manufacturing to create more jobs and assets. By doing so, it intends to increase revenue and reduce the import bill.

Ever since Modi was announced as a prime ministerial candidate in September, a huge wave of optimism has engulfed the market. Since then, foreign institutional investors (FIIs) have pumped $2.34 billion into debt and $13.38 billion into equity. The threat to sustained FII flows would be the US taper, which would end by this year, and a possible US rate hike, starting next year. On the foreign direct investment side, the BJP is open to allowing FDI in all sectors except multi-brand retail.

The initial months of the new government will be very crucial. Any act from the new government that dashes the confidence in the market could result in a huge sell-off. Also, given that Modi’s victory has already been priced into the market to a greater extent, caution is required, as the market could abide by the adage, “buy the rumour, sell on news”.

The Indian rupee closed on a strong note last week. The short-term outlook is bullish. The rupee could strengthen to 58.4 this week, a key short-term resistance. A reversal from this level could take the rupee lower to 59 and even 59.5. On the other hand, if the rupee manages to breach the hurdle at 58.4, it could strengthen further to 58 in the short-term.

For the medium-term, the rupee is poised near a crucial resistance at 58. Technically, this could be a strong hurdle for the rupee, as both the 100-week moving average and the 61.8 per cent Fibonacci retracement level are placed here. Historical studies suggests that every time the rupee strengthens from a new low, the strength of the currency is limited to the 61.8 per cent Fibonacci retracement level, plus or minus 50 paise. So if history was to repeat itself, there is a high probability of a downward reversal from the 58-57.50 zone.

Such a reversal could take the rupee lower to 60-61 levels in the medium-term. On the other hand, if rupee strengthens beyond 57.5, the next target would be 55.