The Reserve Bank of India tried to support the beleaguered Rupee by raising the Marginal Standing Facility by 2 full percentage point, pushing up the cost of funding from 8.25% to 10.25%. This is in response to the failure of RBI to strengthen Rupee via purchasing of Rupee via the secondary markets (Keep note RBNZ, trying to sell NZD if the market wants it stronger is unlikely to work). With this rate hike, and the narrowing of borrowing allowance for banks to just 1% of deposits, is expected to drain liquidity of Rupee and hence prop INR higher. The Central Bank also hope that these measures will compel banks to seek other means of funding – e.g. from depositors which would mean higher rates for short-term borrowings, commercial papers and deposit rates, which will drain liquidity even further. However, this would also mean that mortgages and other commercial loans will be more expensive, discouraging consumer spending and commercial spending during a time when India is fighting the slowdown in growth rates.
The secondary objective of increasing rates in order to attract foreign investments into Indian debt may also fail, as current yield of 8-9% is no match for inflation rates which is standing at 12-13%. Hence if RBI truly want to invite foreign funds in order to help stabilize current Rupee’s weakness, it is highly unlikely that it will succeed just on a 2% increase in the Marginal Standing Facility, when a 2-3 % increase in the Central Bank main Repo Policy Rate may not even be enough.
Hence it is not entirely surprising to see USD/INR falling yesterday, only to find support around 59.0, which equates to a 1.66% fall following the news. To put it in perspective, we’ve seen a larger decline on 9th July, a fall of more than 2.5% following the historical higher of 61.21. That past decline was driven by technicals and fueled by USD weakness and not due to a shift of interest rates, which tend to move currencies more. Hence it is clear that RBI has failed to rally INR significantly following the announcement.
From a technical setup, staying above 59.0 affirms the consolidation zone from 59.0 – 61.0 Even though price is trading below the rising trendline, the overall bias is still upwards. Stochastic readings are currently pointing lower following yesterday’s decline, and suggest that perhaps a retest of 59.0 may be possible once more, but as long as 59.0 stays, the door for a retest of the rising trendline remains.
From the short-term perspective, price is conclusively bouncing higher from 59.0. Stochastic readings supports bull cycle scenario which will allow price to test 59.8 which is the intersection of the rising trendline (from daily chart) and the consolidation channel bottom from 59.8 – 60.20. If 59.8 is breached, the decline yesterday will be invalidated and the broader bullish scenario will quickly take hold once more, bringing price back on track to potentially yet another new high.
Looking at the failure of price to keep itself depressed following Bernanke’s continued QE talk last week, it is clear that INR bears are trumping even the weakness in USD. Should USD strength come back in the fore once more, the bullish impact on USD/INR will be devastating.
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