Indian Rupee: Stable range with shallow gains against US Dollar – DBS

DBS Group Research notes that after earlier rupee outperformance driven by intervention and inflows, USD/INR has settled around the mid-94 handle. With Oil prices rising and the Dollar supported by US rate hike expectations, they expect USD/INR pullbacks to be shallow, although recent inflows have reduced the risk of sharp one-sided rupee depreciation in the near term.

Inflows support the rupee as RBI liquidity pressures persist

“Markets attention is squarely on the liquidity after-effects of strong inflows under the swap windows. The banking system surplus jumped past INR 10trn this week surpassing 2022 and Covid highs, with the durable balance widening sharply higher to INR 14trn, suppressing overnight call rates. This compares to average INR 1trn surplus in late-June.”

“After the initial bout of rupee outperformance on account of intervention and inflows, the USD/INR settled into a range around the mid-94 handle this week. With oil prices creeping higher and the dollar benefiting from US rate hike expectations, pullback attempts in the USD/INR are expected to be shallow.”

“Recent inflows have nonetheless given the authorities additional firepower, which has helped to lower the tail risk of a sharp one-sided depreciation in the currency in the near-term. August inflation, due next week, could quicken to 4.8-4.9% from 4.4% month before, on a broader rise in food, apart from a pick-up in precious metals, pushing up core as well.”

“The weak take-up at yesterday's 30-day VRRR suggests market participants are resistant to lock up funds ahead of a potentially higher policy rate, implying that longer-tenor VRRRs may remain less effective until the October meeting should current rate hike expectations remain. If the RBI seeks to drain liquidity before then, measures will likely exert further upward pressure on bond yields”

“Indian rates continue to face upward pressure as the RBI has little incentive to push back against the recent hawkish repricing at a time when system liquidity remains exceptionally abundant. The immediate challenge is that surplus liquidity has become more difficult to absorb.”