INR likely to remain firm due to strong inflows unless there is turn in global risk factors: Commerzbank

The Indian rupee (INR) continued to strengthen for the fifth consecutive month in April, by another 0.9 percent to 64.25. Year-to-date, it is up by nearly 6 percent against the greenback, making it the 3rd best performer in Asia behind TWD and KRW.

Over this period, CNY is up only 0.8 percent. This has raised questions on whether RBI has changed its policy towards INR and is accepting a strong currency or will even allow further appreciation to help keep inflationary pressures at bay., Commerzbank reported.

The Reserve Bank of India (RBI) has been restrained on intervention due to the strong net foreign portfolio inflows into both the equity and debt markets and to avoid worsening the excess liquidity situation due to the increased bank deposits due to demonetization. If the FX interventions (i.e. RBI buys USD) are not fully sterilized (i.e. more bonds are issued to absorb the increase in INR), it will add to domestic liquidity.

The reason RBI is concerned about a prolonged period of excess liquidity is because of fears of stoking inflation. RBI has already stated that it intends to bring the liquidity situation back to a neutral position. It may still be a few months away but RBI is in discussion to amend the RBI act for it to utilise the standing deposit facility (SDF) to soak up liquidity.

"As such, for the meantime, we expect INR to remain firm due to strong inflows unless there is a turn in global risk factors," the report said.