Indian rupee’s recent gains could be short lived

Indian rupee
Potential surge in dollar demand in months ahead and a US interest rate hike could see rupee facing pressure. Image Credit: Shutterstock

Dubai: Indian rupee has been gaining during the past few weeks despite the nationwide surge in COVID-19 infections, rising mortality rates and lockdowns across several key states.

The Indian currency gained to 72.83 a dollar on last Friday from 75 a dollar in mid-April. Rupee has been broadly tracking the local stock markets that maintained the gains despite heightened volatility.

Some stock market sell-offs by foreign institutional investors were seen in early May as infections and death rose. However, resilient domestic investor support to equities saw some of the foreign institutional investors (FIIs) returning to Indian equities resulting in a surge in supply of dollar in the domestic market.

Large supply of dollars from FII investments, combined with excess availability of the green back with both merchants and banks have seen the rupee strengthening in the recent weeks.

RBI intervention

Reserve Bank data showed that in the merchant market (in both spot and forward segment) there was an excess supply of $86 billion as of February end. The large supply of dollars has ensured some appreciation in the rupee against the dollar in recent weeks. 

Additionally, the central bank intervention in the market to neutralise rupee liquidity as part of using forex resources as a mechanism inflation control has also resulted in some increase dollar supply with both merchants and banks, resulting in temporary gains.

Forex supply

Rising forex reserves too are helping the rupee to stand its ground. Inching towards the record high seen in January, the country’s foreign exchange reserves swelled by $563 million to $590.028 billion in the week ended May 14, according to data from the Reserve Bank of India (RBI).

However, the supply demand dynamics in the forex markets could change once imports gain momentum when COVID-related restrictions ease. Additionally, upcoming massive government borrowings to cover COVID-related expenses combined with a potential rise in dollar interest rates could bring the rupee under pressure in the second half of the year.

Looking at the relatively weak economic fundamentals combined with potential surge in dollar demand in months ahead, Indian rupee could experience downward pressure in the second half of this year.