Rupee Rocks as Rest of World Worries

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- INR supported by multiple factors

- Weak oil price, FDI flows, carry trade

- Technical break suggests strong bearish bias

The Indian Rupee is strengthening as a result of a combination of factors, including lower oil prices, the resilience of India’s manufacturing sector, higher FDI flows and increased demand for the Rupee from carry traders.

The GBP/JPY pair recently broke below the 86.50 level as a result of the rise, which was a level identified as key to opening the way for more declines - potentially as far as 84.75 or 80.45.

A major source of Rupee gains has been the falling price of oil which the country has to import in high volumes. When oil prices fall, therefore, it lowers the country’s trade deficit supporting the Rupee.

The price decline came despite the decision by OPEC this week to extend its current production cap until the end of 2019.

This would normally be expected to support oil prices but it did not this time around. Continuing pessimism about the China-U.S. trade relationship continues to weigh as it is expected to cause global disinflation.

“Brent crude has dropped over 5%, despite OPEC efforts to prop up prices. Great news for import-dependent nations like India, and it comes at a critical point for the rupee,” says Jeremy Boulton, an analyst at Thomson Reuters.

Boulton also sees the Rupee at a technical vulnerable point against the U.S. Dollar. The same seems true for the GBP/INR pair, where the break below 86.50 appears to have finally confirmed the breakdown of the massive bearish head and shoulders (H&S) pattern on the weekly chart, opening up the potential for much lower prices.

The break comes after much flirting with the neckline and even the formation of what looked like a potentially bullish reversal pattern, at one point. However, this recent bout of INR strength has definitively broken the neckline and opened the way for lower prices.

Longer-term drivers are at play which are increasing the possibility of a stronger Rupee and underpinning the major technical moves.

One of these is that Indian Manufacturing remains in expansion territory and relatively robust. Although the PMI fell to 52.1 from 52.7 in June, this was still abaove the expected 51.7. Most other country’s PMIs are in contraction territory and declined below expectations.

The resilience of Indian manufacturing also supports the view that India is proving a beneficiary of the trade war between the U.S. and China.

India’s strong profile as a replacement candidate for the low cost manufacturing done in China makes it a natural alternative.

India also has the potential to replace U.S. agricultural imports to China. It is a large regional grower of soybeans, for example so could fulfill China’s need for the crop if it were to repeat a ban of U.S. soybeans.

“India is relatively unexposed to trade-tension risks and should benefit from lower commodity prices. As oil and other raw input prices fall, economic growth should pick,” says Hans Redeker, a strategist at Morgan Stanley.

Another driver of the strengthening Rupee is the rise in India’s FDI flows, or inflows of foreign investment. Inflows are shown to be rising into India’s equity and bond markets, with demand for bonds temporarily outstripping equities.

Carry trade inflows appear to be another driver of the Rupee. Carry traders borrow in a currency where lending rates are low like the Euro or the Yen and then park the proceeds in a currency where interest rates are higher like the Rupee. They then earn a profit from the difference.

Falling interest rates around the world and the ‘race to the bottom’ by major central banks are driving interest rates down in most countries, but in India, they remain relatively high.

Although the Reserve Bank of India recently cut interest rates they remain relatively high at 5.75%.

This would give a Sterling-funded carry trade a 5.25% annual gain since the UK base lending rate is 0.5% - the gain being the difference between the two.

The Indian economy’s “reliance on domestic demand insulates it to a large degree from global trade tensions,” says Krishna K, an analyst at Thomson Reuters, who adds the recent narrowing currency account deficit is a further cause for Rupee holders to rejoice.

The Rupee’s gains on Friday, July 5, are further linked to the market’s positive response to the Indian budget, in which the Indian finance minister Nirmala Sitharaman announced the country’s budget deficit had fallen to -3.3% of GDP in 2019, which was below forecasts of -3.4%.

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