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SAILING IN THE UNCERTAIN WATERS

Reeling from unanticipated global risk events in 2016 such as the UK Brexit vote and the election of US President Trump, markets were hoping for a less-eventful 2017. This year, even as global sentiment and growth prospects have improved (IMF has raised its global GDP estimates to 3.5% from 3.4%); the journey has been just as volatile. Market watchers will concur that economic and political risks continue to linger in the US, even as their nature may have undergone a change. Additionally, global trade protectionism and the volatility induced by UK and Eurozone elections continue to raise investor concerns.

Indian markets have clearly not been impervious to these externalities, with the rupee being a case in point

  • In 2016, the rupee weakened nearly 5% against the dollar, while in 2017 it is currently trading 2.2% stronger
  • In general, USDINR has been extremely sensitive to US dollar moves, which in turn has been sensitive to incoming updates on the US macro-political scenario
  • Amid continued lack of clarity on the US fiscal stimulus and still-subdued inflation, the greenback has weakened, leading to INR strength
  • Among other factors and in a continuation of 2016, concerns related to China’s slowing economic growth, its impact on overall EM outlook continue to affect the rupee

Alongside, domestic drivers have also played a large role in unanticipated INR movements

  • Investor optimism generated post Union Budget gathered pace following better-than-expected performance of the ruling government in March state elections, triggering heavy capital inflows and sharp INR strength
  • The change in RBI monetary policy stance from accommodative to neutral further added to rupee strength. While the central bank has tried to contain rupee volatility to some extent, surplus systemic liquidity has constrained its ability to intervene actively 

What do we expect

Notwithstanding outperformance of the USDINR vis-à-vis peers, the rupee remains prone to unexpected moves during the rest of the year. Even as our bias remains for slight depreciation during H2 2017, event-related spikes in the currency cannot be ruled out. Uncertainties persist on several fronts including US rate outlook and its divergence with other advanced economies. Geopolitical tensions including those related to N. Korea and Middle East remain risks. In terms of politics, elections in Germany in September and in Italy by mid-2018 are yet to unfold. Other likely triggers include US President Trump’s much-awaited policy announcements and their implementation.

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