The Three Reasons Why The Rupee Is Strengthening

The Indian rupee continued to strengthen for the fourth straight session, trading at its highest in two-and-a-half months.

The currency has gained 1.4% in just the last five trading sessions. On Tuesday, it rose to 73 against the dollar, up another 0.3%.

Flows: Debt Flows Made A Comeback In August

Inflows into equity markets were strong until June, although July saw net outflows of Rs 11,308 crore. In August, foreign investors brought in a net of Rs 368 crore. However, recent initial public offerings have meant that money has come in when subscriptions open, even as some of it flows back out if allotments are not made.

The rupee will continue to garner support from equity markets as more than 10 companies are about to be listed and will likely raise close to Rs 17,000 crore, according to Imran Kazi, vice president-risk advisory with Mecklai Financial Services.

But a change in trend was witnessed in debt flows in August, which after being tepid for months, surged. A net of Rs 11,865 crore came into the debt market in August, showed data from National Securities Depository Ltd. This is the highest since March 2019. Another Rs 2,063 crore came into debt via the longer-term voluntary retention route.

According to market participants, the increase in debt flows has only come in the last couple of days. It is not clear if this is attributable to a one-time flow on account of a specific investment.

RBI Takes A Breather From Intervention

While foreign flows, at least on the equity side, have been strong for some time, the Reserve Bank of India has kept a tight leash on the rupee by absorbing the flows and preventing undue appreciation.

This has led to a build-up in India's forex reserves to $611 billion. The central bank has also intervened in the forwards market actively, since intervention here has more limited consequences for domestic liquidity conditions.

Over the past few days, however, the RBI has been absent from the market.

According to the treasurer of a foreign bank, who spoke on the condition of anonymity, the RBI was not seen to be in the market on Friday and then even on Monday. The market will now wait to see when the RBI returns and the levels at which it chooses to draws a line in the sand.

The core liquidity surplus, which includes government cash balances, is running at over Rs 11 lakh crore at present. Large-scale interventions in the spot forex markets will only add to that. In addition, a stronger rupee can help ease imported inflation, even though it is negative for exports.

"The central bank, in the past couple of months, has been very active on the buy side whenever there was a drop in the dollar-rupee into the 74.10-74.30 band but has chosen to stay away since Friday," Kazi said.

India Is Not Alone In Appreciating 

The Indian rupee's gains are not in insolation. Most Asian currencies are gaining.

Over the past one week, the Thai bhat has gained 2%, while the Malaysian ringgit has gained 1.5%. The rupee, with gains of 1.47%, is the third-biggest gainer among Asian peers.

But not everyone expects the gains in the rupee to stick,

"The rupee is expected to trade with a negative bias on risk aversion in global markets and surge in crude oil prices," ICICI Securities said. "Additionally, concern on uptick in daily Covid-19 cases in India may hurt the rupee. However, weakness in dollar may prevent a sharp fall in rupee," the brokerage said in its daily note.