The Indian rupee has strengthened to its highest level in nearly two months because of healthy foreign-currency inflows and a weakening in the US dollar.
But analysts are not quick to push the currency higher in the near term as foreign exchange swap-based flows fall off the radar and crude oil prices continue to rise.
The rupee rose about 0.5 percent to just above ₹94.49 against the US dollar in early afternoon trade in a market that this is the highest level in ten weeks.
For the week, the currency has also been up, with the currency gaining on the back of better liquidity and dollar supply in the domestic market.
The large amount of foreign currency that entered India through special deposit and swap arrangements backed by the Reserve Bank of India (RBI) is one of the significant factors that has led to the recent recovery.
These flows raised the country’s foreign exchange reserves and helped the rupee to recover.
The foreign-exchange reserves of India are reaching record levels and the RBI has a much more powerful tool to intervene in the currency market when required.
The central bank has been closely monitoring the currency market, especially as global commodity prices and geopolitical tensions increase the risk to the rupee.
Swap Support Nears Its End
Despite the rise in the rupee’s recent rise, analysts believe that perhaps some of the factors driving some of the reasons behind the rally may not last.
The special foreign exchange deposit schemes have ended on August 31, so the extra dollar liquidity created through the special foreign exchange deposit schemes is no longer providing the same boost to the market, and the dollars in those systems won’t be able to carry the same energy to the market.
After all, it has raised concerns about what will happen to the rupee as the short-lived help in the short term will fade away.
Without those kinds of flows, the currency will once more be sensitive to import demand, foreign portfolio flow, and global dollar movement.
The RBI’s presence in the foreign exchange market is also expected to remain important.
Market participants have said central bank intervention is not so much a surprise as a way to prevent sharp moves in the rupee.
Crude Oil Adds to Currency Concerns
A rising crude oil price is a bigger challenge for the Indian currency. Brent crude is up well above $96 a barrel as the US and Iran are getting more and more tense, and there is mounting concern over the global supply of oil.
The increase in oil prices has taken place weekly on a large scale, putting pressure on oil-dependent economies like India that depend on imported crude.
When oil prices increase, Indian importers have to pay for energy purchases with dollars. This can increase the demand for the U.S. dollar and puts pressure on the rupee.
A prolonged rise in crude prices will also put India’s trade balance and inflation outlook under strain, and the currency will be more vulnerable if the oil rally continues.
Market Focus Shifts to Global Signals
Traders are likely to closely track crude oil prices, US dollar movements, foreign investment flows, and signals from the US Federal Reserve.
A weaker dollar around the world has provided some relief to emerging-market currencies, including the rupee.
But higher US bond yields and expensive crude prices may not help the rupee catch up with the dollar and limit its recent gains.
In the near term, the rupee’s rise to a two-month high is a reflection of good sentiment and very good liquidity.
But with the benefits of temporary swap-related inflows fading and oil prices sharply higher, analysts say that the currency could be put under pressure again in the coming weeks.
RBI foreign-exchange reserves are a large cushion against excessive volatility.
But the rupee will be able to maintain its recent revival when real market conditions are not only good but also temporary.
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