Rupee rallies sharply on FPI flows and stronger Yuan

The rupee gained sharply against the greenback in the last couple of days. From almost touching 83/$, the rupee has gained Rs1.50 to touch Rs81.50/$ in mid-day trades on Wednesday 09th November 2022. The rally has been quite sharply, especially after the rupee has shown consistent weakness in the last few months. Since the start of the year 2022, the rupee has weakened from Rs75/$ to $83/$. The RBI has not lagged behind; in fact they deplete their reserves by nearly $120 billion trying to defend the rupee but there is only so much the RBI intervention could do. The rupee panic finally appears to be changing.

What are the factors that have strengthened this sudden strengthening of the rupee vis-à-vis the dollar. One argument is that the Fed has already indicated that, going ahead, rate hikes would be more subdued and calibrated. Which means, the rate hike intensity could go down to 50 bps in December and probably 25 bps after that. The impact was already visible in the Bloomberg dollar index (DXY), which fell from 112.5 to 110.5 levels. There was a lot of bullishness built on the dollar on hopes that the hawkishness would result in a surfeit of risk-off flows into the US. Apparently, that story may not have too much of credence.

The Chinese Yuan factor

One of the high frequency factors that triggered the strength in the rupee was the strengthening of the Chinese Yuan. If you rewind back to late 2015, weakness in the Chinese Yuan had suddenly resulted in a forced weakening of the rupee. After all, being EM currencies, they need to be compete and cannot allow one currency to devalue beyond a point. A similar situation was playing out in the current context. However, China has reported better than expected trade data and the GDP growth data is also likely to indicate that the worst may be over for the Chinese Yuan. That gave a boost to the rupee.

The Chinese Yuan had already weakened to its multi-year lows in the previous month and with trade and GDP data coming out stronger than expected, the worst appears to have been factored in. Apart from the stronger Chinese Yuan, Indian banks were consistently selling dollars on behalf of overseas investors and that also gave a fillip to the Indian currency. After depreciating nearly 10% against the US dollar in 2022, the rupee is not looking all that overvalued in terms of dollar parity. That has resulted in a bottoming out of the Indian rupee amidst a topping out of the US dollar. 

FPI flows turn for the better in November 2022

That was the pleasant surprise in the month of November. FPIs last infused $6.44 billion in the month of August 2022. Subsequently, the FPIs took out $1 billion in September and in October the FPI flows were neutral. In both these months, the FPIs turned to aggressive selling in the second half of the month after being net buyers in the first half. Now that picture appears to be turning for the better in November with over $2 billion infused in the first 5 trading sessions of the month. Here is a quick preview of the FPI flows in the first week of November 2022.

Data Source: NSDL

As can be seen from the above table, FPIs have been aggressive buyers in the equity markets in November infusing $2.04 billion in the first five days or Rs16,878 crore of net inflows. FPIs are still disappointed that the Indian government did not do enough to get the Indian bonds included in the JP Morgan global bond indices and that has resulted in some net selling in debt. However, the equity flows are robust and that is clearly a signal of greater confidence that FPIs are showing on the Indian story.

Fed language holds the key to the future of the rupee

However, it is not going to be a one-way ride for the rupee. It is likely to remain volatile as the FPIs grapple with challenges like US rate action, US inflation, the US mid-term election outcome, UK growth, China trade etc. The US Fed has already indicated that it may opt for rate increases of a slower pace in the months ahead. With 375 bps of rate hikes done, the Fed is likely to take it easy for now. Higher US interest rates lead to a flow of global capital to the US markets, exerting pressure on emerging market currencies such as the rupee. For the Indian rupee, it is time to play catch up after a rather precipitous fall.