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The wobble in INR appears to be in the rear-view mirror and modest appreciation should unfold over the coming months.
RBI interventions to cap INR strength: USDINR has traded in a range of 63.54-65.93 since March with the RBI intervening more aggressively on the downside (FX reserves including forwards increased by $50bn). On the basis of technical analysis, we foresee that INR could appreciate toward 63.60. While USDINR could head lower it is unlikely to breach the August low (63.54) unless RBI intervention becomes less proactive or EM currencies strengthen a lot.
Positioning might help INR bounce: Fast money positioning is the primary culprit for INR weakness since mid-September given that bond flows have remained robust. The offshore-onshore FX yield differential has shifted from short dollar to long dollar positioning over the last month. With the market more balanced, carry trades should resume.
Capital flows should be stable in 4Q: FDI flows will likely continue to support the modest CA deficit. Higher FPI limits provide some additional space for foreign inflows, especially in corporate bonds. However, given the risks of the substantial inflows into local bonds this year ($20bn) reversing, we prefer downside option structures to NDF exposure.
On NSE currency futures market, USDINR contract of the near month October month delivery ended at 65.29 on the NSE. It is noted that the October contract OI (open interest) declined 14.40% from the previous day, whereas OI of November expiries increased 12.60% in the previous session.
It is expected that the dollar is on the verge of encountering supply pressure at higher levels. Snap rallies and exploit upside opportunities in the pair to deploy shorts on the USDINR.
Contemplating above aspects, on both speculative as well as hedging grounds, we advocate initiating shorts in futures contracts of mid-month tenors.
