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February 10, 2021 Currency Exchange
5 minutes, 42 seconds Read

USD to INR Analysis for 2021: Is Asia’s worst performing currency of 2020 headed for strength?

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The year 2020 turned out to be an extremely turbulent year as the country battled the surging pandemic. It started off around the level on 71.40 on 1st January 2020 and then started off a slow and steady decline towards 74.00 in February/March as the first signs of the virus appeared. I remember that the drop continued as the first lockdowns were announced leading to a virtual standstill of all manufacturing and service sectors with large migration of labour from the urban areas back to rural India. The economy collapsed and rupee fell to an all-time low of 76.92 by 22nd April 2020.

As fears of an imminent collapse of rupee hit the markets, RBI acted aggressively selling dollars to fight off the speculators and signaling to the importers not to buy forward dollars to hedge their payments in any panic. The central bank again acted strongly to keep the markets calm after the border row with China flared up, not allowing rupee to be sold off by overseas speculators which was a great move in my opinion.

Also Read:  USD to INR Forecast for 2021, 2022

The defense of the rupee had large political overtones as I think any panic in the markets would lead to large withdrawal of fund by the FPI’s, putting further pressure on rupee and bringing international focus to the country in a negative manner. RBI was greatly helped by a large inflow of dollar funds relating to the share sale of a large telecom company and its holding company which generated, along with some further share sales by a couple of other large companies, over $30 billion in a matter of few months.

Forex reserves hit record high

The rupee soared to 72.75 by 1st September even as RBI absorbed most of the oversupply of dollars in the system helping our forex reserves rise to record highs. Rupee ended the year at 73.00, a good recovery in my opinion from the lows of year despite the economy still struggling as the pandemic continued to surge across the country.

From my understanding, the negative impact of the pandemic had put huge pressure on the government, forcing it to provide huge stimuli to the economy to prevent a total collapse. Economic fundamentals got hit hard last year and the market waited for the Budget to get a sense of the governments course of action.

I truly think the forced stimuli have put the fiscal deficit totally out of synch with the targeted level in last year’s Budget. A fiscal deficit of 9.4% has been provisionally announced, higher than what most analysts expected. The Budget also laid out a target of 6.8% for the next financial year, still much above the 3.5% target set in 2019-2020. However as this was something in common with what was happening in all major economies any negative impact on rupee has not been seen at all so far. International rating agencies have also not commented negatively on this, removing fears of a rating downgrade. However, should the economy fail to pick up in the coming months, in contrast to the government’s expectations as expressed in the Budget, I think fears of a rating downgrade will emerge. This also brings me to believe that it will lead to huge outflow of funds by the FPI and RBI will have a hard battle to protect the rupee. The fact that RBI has succeeded in building up record forex reserves will help it protecting the rupee and prevent a large slide of rupee should a rating downgrade occur.

Also, Read 1 USD to INR from 1947 till now, Historical Exchange Rates Explained

Impact of Budget 2021 on USD-INR

As I was keenly following the Union Budget 2021, the government announced no fresh taxes or hike of taxes to fund the excess expenditure and reduce the fiscal deficit for the coming financial year. While it has said that the economic resurgence in the coming months will lead to generation of larger revenue, it has decided to meet the deficit by borrowing in the market. This has immediately led to a hike in yields of sovereign bonds over the last two days and the pressure on the yields will remain. This will also put pressure on inflation and also hike cost of corporate borrowing, leading to pressure on corporate profits and performance.

My take on it is that any drop in corporate performance will hit the equity markets and could lead to a gradual sell off and withdrawal of FPI’s from the market, putting pressure on rupee. RBI could partly meet the liquidity issue in the markets by resuming its policy of buying surplus dollars and putting in rupee liquidity. This will result in rupee being under pressure, I believe. We have seen the impact in the market already in the two days after the Budget presentation as rupee has failed to gain against the dollar despite the huge inflow of dollar funds by FPI’s.

Must Read: How much was 1 USD to INR in 1947?

The equity markets have surged by nearly 5% in two days, touching near record levels, but rupee has stayed put in the 72.90-73.00 band. I think the problem for RBI will arise if the FPI inflows slow down as any sustained dollar buying by RBI will the lead to a decline of the rupee. From what I have read and this is pretty much public information, India currently has more than USD 590 billion in forex reserves, the highest ever, up by USD 119 billion compared to the previous year.

Also queering up the pitch for the rupee is the steady rise in global crude prices. Brent prices have risen sharply in the last few days with current level of $57.60 being just below the strong resistance of $60-63. Should that level be breached we could see some large dollar buying by speculators and others as India continues to rely heavily on imported crude. According to me, a further hike in domestic petroleum products might be difficult and the government might be forced to cut excise duty, which again will put pressure on the fiscal deficits.

Conclusion

To conclude things off, I think that most of the factors, fundamentals at least, will make it difficult for RBI to keep rupee at current levels. It will heavily depend on the recovery of the economy and a successful fight against the pandemic. My take on the whole scenario is simple: the current vaccine inoculation, if it succeeds in combating the pandemic, will be the greatest supporting factor for the economy and rupee in the coming months. Results so far have been mixed making it difficult to make a good guesstimate.

I therefore believe that taking all the above factors into account, rupee is likely to trade in a 72.70-74.50 band this year, with RBI using its large reserves to slow down or stop any depreciation of rupee beyond that point.

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