RBI Monetary Policy: Rupee strengthens against dollar, but there's a catch

The Indian Rupee has been trading over 67-mark against US benchmark dollar index for third consecutive day ahead of RBI's monetary policy announcement which is scheduled at 2.30 pm today. In early opening on Wednesday, the domestic currency strengthened by 11 paise to 67.04 against the American currency at the interbank forex market.  RBI Governor Urjit Patel, along with six-member Monetary Policy Committee (MPC) for the first time in history decided to hold the policy meet over 3 days, and all eyes are now on what the central bank will decide as far as the repo rate is concerned. Following this, Indian rupee gave away one-month high gain which was boosted by the announcement India's GDP numbers of 7.7% in Q4FY18 last week. Indian rupee last week touched near 66-mark per dollar. Many analysts are expecting either another status quo or a rate hike and it needs to be highlighted here that rate cut dilemma is not in the picture. 

At around 1222 hours, Indian rupee was trading at 67.063 above 0.033 points or 0.05%. 

Anindya Banerjee analysts at Kotak Institutional Equities said, "Rupee opened marginally higher, around 67.10 on spot, against US Dollar. Most Asian currencies are on the front foot against USD. Crude oil prices have bounced off their yesterday lows, with Brent now at at 75.60 dollars a barrel up from 73.88 yesterday. Majors are stuck in a sideways phase against USD. Today, Rupee can take cue from the RBI monetary policy. Theoritically, when central bank commits to keep real rates higher, either through immediate action or with a hike over the near term, it has a positive impact on the currency. High real rates induces carry traders to play carry trade on INR." 

Banerjee explains, " However, a rate hike is generally negative for long bonds, especially at the inception of the rate hike cycle. Generally, as the hikes progress, yields curve flattens, which means, short term rates react much faster than long term yields, till a point is reached, when the yield curve inverts."

Indian yield curve has remained steeper going into 5 year, which is currently at 7.85%, thereafter it flattens out. Spread between 1 year yield, close to 7.10%, is quoting a term spread of 110 bps over repo. 

Banerjee adds, ". Historically, such a wide spread is indicative of market pricing in at least two hikes from RBI. As we wrote yesterday, if CPI hovers closer to 5.5% by FY19 end, then RBI would have to hike rates between 75-100 bps to maintains fulfill its committment on real rates.Technically, USDINR is now facing resistance around 67.30 and then 67.50 levels on spot."

" Sustained trading above 67.50 on spot may be needed to confirm that the downtrend has reversed and uptrend has resumed. Incase of a reversal, we would go long to play for 68.00 and higher levels. Nevertheless, as long as 67.50 is intact, one can look to short on rise for a re-test of 66.85 and then 66.60 levels on spot," said Banerjee. 

In previous trading session, the Indian rupee had shed 4 paise to end at 67.15 against the US dollar. 

Moreover on Wednesday, the benchmark Sensex was trading at 35,098.58 above 195.37 points or 0.56%, whereas Nifty 50 was above 62 points or 0.59% trading at 10,655.25.