FxWirePro: Major driving forces of obstinate INR – Bullish and bearish scenarios and hedging vehicles

Indian rupee is the only EM Asia currency that has not risen against the USD since the start of the year. While it is down only slightly against the USD, it has nevertheless underperformed the broader USD trend.

The portfolio flow backdrop has been quite soft over the past month or so. The RBI’s decision to hold steady on rates at the December meeting saw strong outflows from Indian bonds for the same month. We have also seen net equity outflows from offshore over this same period and this trend has continued into 2017. This bucks the broader trend of net equity inflows into the region for the first few weeks of 2017.

Overall, our bias is still to look for INR outperformance in 2017. However, it seems too early to embrace such a view. The INR NEER is still trending lower and we need to see a more supportive portfolio inflow backdrop before embracing such views.

Bearish INR risk scenarios: (1) Demonetization drives a sharper correction in the economy than expected; (2) Oil prices spike to $60/bbl; (3) Global equity market sentiment weakens.

Bullish INR risk scenarios: (1) Reform agenda gains further momentum; (2) FII limits are increased; (3) New RBI Governor reduces intervention bias.

We advise selling USDINR 1m NDF at 68.18, with a target around the previous range prior to the recent spike at 67.00 (+ 1.98%) and a stop above the previous highs at 69.50 (1.14%).  The trade horizon is 2-4 weeks and the trade has a positive carry of 39bp/month.

The main rationale for upholding this trade is that the shorts in USDINR near highs on getting past of outflows USDINR has rallied by 2.89% in just two and half months (from the night of US elections and also India’s announcement of demonetization of high-value currency bills) and briefly touched all-time highs on November 24.