Rupee Faces Moment of Truth With $2.6 Billion Outflow Before Fed

  • Currency has weakened 2.4 percent since end of October
  • Oil drop, faster India growth to support rupee, ABN Amro says

India’s rupee is feeling the heat as the Federal Reserve looks set to raise interest rates for the first time in a decade.

The currency, touted as Asia’s most resilient to a U.S. rate increase by Australia & New Zealand Banking Group Ltd., has extended declines in December after weakening 2.1 percent last month in the region’s worst performance. Rising odds of a Fed liftoff as early as Wednesday saw global funds cut holdings of Indian bonds and stocks by $2.6 billion since Oct. 31.

Policy makers are seeking to avoid a repeat of 2013, when the Fed’s signal to end its unprecedented bond purchases sent the rupee tumbling to a record 68.845 a dollar in August that year. Traders say the Reserve Bank of India intervened this month as the currency slid past the 67 level and the monetary authority said for the first time it will step into the exchange-traded derivatives market if needed.

“The Fed is absolutely key,” said Divya Devesh, Standard Chartered Plc’s Asian foreign-exchange-strategist in Singapore. “Markets are currently working under the assumption that we will get a dovish tightening, but central banks have surprised in the past, so taking a cautious approach is warranted.”

The rupee has weakened 2.4 percent since the end of October to 66.88 a dollar as of 11:37 a.m. in Mumbai, according to prices from local banks. The Bloomberg Dollar Index, which tracks the greenback against 10 global peers, advanced 1.6 percent in the period as the probability of a Fed liftoff at the current meeting jumped to 78 percent from 50 percent. Standard Chartered revised its year-end forecast for the rupee mid-November to 67 a dollar from 66 on account of the “broad dollar strength,” Devesh said.

One-month implied volatility, a gauge of expected rupee swings used to price options, has jumped 61 basis points since Dec. 11 to 6.43 percent in the run up to the Fed’s meeting, poised for its biggest weekly advance since August.

The RBI “intervenes in the domestic foreign-exchange market as and when required in order to manage excessive volatility and to maintain orderly conditions,” it said in a Dec. 9 statement. “It has been decided to intervene in the Exchange Traded Currency Derivatives segment, if required.”

RBI’s Defense

ABN Amro Bank NV, the top rupee forecaster, is sticking to its end-2015 forecast of 66 a dollar as it expects the central bank to defend the currency and plummeting oil prices to improve the finances of Asia’s third-largest economy.

“We do expect the RBI to defend weakness in the rupee,” said Roy Teo, a Singapore-based senior foreign-exchange strategist at ABN Amro, which had the most-accurate estimates in Bloomberg’s quarterly rankings. “The decline in oil is positive for the economy and the inflation outlook. Fundamentals will support the rupee in coming months.”

India’s gross domestic product rose a faster-than-estimated 7.4 percent in the quarter through September and the economy is set to outpace a slowing China this year as Prime Minister Narendra Modi boosts infrastructure spending. The nation imports about three quarters of its oil.

RBI Governor Raghuram Rajan, who took charge at the monetary authority within days of the rupee’s plunge to a record low in 2013, has since boosted India’s foreign-exchange reserves to provide a cushion to fight global shocks. The hoard stood at $352.1 billion as of Dec. 4, compared $275.5 billion at the end of August 2013.

“We are most constructive on the rupee, expecting the currency to be the most resilient on account of its low export exposure, improvement in its external position and large foreign-exchange reserves,” Khoon Goh, a senior strategist at ANZ in Singapore, wrote in a Dec. 8 report.

‘Risk Environment’

Even as the impact of higher U.S. rates remains to be seen, the rupee is headed for a fifth straight annual decline, having lost 5.7 percent this year. Barclays Plc and ING Groep NV are among those seeing more weakness going into 2016, with Barclays predicting a drop to 68.50 a dollar by March 31, according to estimates compiled by Bloomberg.

Outflows from Indian bonds contributed to a surge in the benchmark 10-year sovereign yield to a four-month high of 7.82 percent on Dec. 14. The yield, which was at 7.77 percent on Wednesday, has jumped 12 basis points since end-October. The S&P BSE Sensex index of shares has slumped 4.3 percent since Oct. 31.

“The rupee will take its cue from the risk environment stemming from the Fed meeting,” said Viraj Patel, a currency strategist at ING in London, who expects the currency to weaken to 67.50 a dollar by March 31. “Our base case is for a 25-basis point rate increase but a cautious message to keep market expectations in check. Stronger U.S. inflation data in the first quarter will see markets reprice Fed rate hike expectations and it’s difficult to see risk assets performing well in that environment.”

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