Finance & Economy

India: External Sector Monthly Forex Market Update Navigating the Storm

Published: April 20, 2023

Global Overview 

Dollar Index  

  • The dollar index depreciated 2% in the last month after a  series of bank runs and economic data releases indicated  that the Federal Reserve would choose to take its foot off  the pedal sooner than previously expected. 
  • US Fed hiked the target rate by 25 bps to 4.75-5% at the  

Dollar Weakness 

March FOMC meeting, on concerns over sticky core inflation  and a tight labour market. The dot-plot was however left  unchanged with the terminal rate of 5.1%, indicating only  one more 25 bps rate hike on the cards.Latest data for nonfarm payrolls, job openings, inflation and the minutes of the March meeting pointed to the dwindling  of rate hikes beyond May. Nonfarm payrolls rose  by 236,000 in March, posting its smallest gain

December 2020, while the unemployment rate came in line with expectations of 3.5% in March. CPI inflation  eased to 5% y-o-y last month, its slowest pace since May 2021, while core CPI inflation continued to pose  as a pain point rising to 5.6% in March from 5.5% in the previous month. Meanwhile, the minutes of the  March FOMC meeting showed that several Fed officials had considered a pause in the rate hike cycle post  the bank failures. 

  • Growth prospects remained clouded, as Q4 2022 GDP was revised lower to 2.6% y-o-y from initial estimates  of 2.9%. Recent indicators of retail sales and PMI too reported a loss of momentum. Retail sales grew 2.9%  in February, its smallest annualised gain since July 2020, while manufacturing PMI came below the 50-mark  for the fifth straight month in March. 
  • With financial stability risks contained and macro data showing signs of softening, a final 25-bps rate hike at  the May FOMC meeting looks likely. We thus maintain a bearish view for the dollar over the coming month.  Over the course of the year as well, the dollar could continue to remain weak as the impact of the total 475  basis point of rate hikes on the real economy is yet to pan out. The market has factored in bets of rate cuts  in H2 2023 which is weighing on the dollar. As per the CME FedWatch Tool, markets have currently priced  in a 40% probability of a 25 bps rate cut at the November FOMC meeting. 


  • The euro gained over 3% over the past month on improving  global risk sentiment and optimism on the growth front  presented ECB with the leeway to press ahead with further  rate hikes.
  • At the March policy meeting, ECB hiked the policy rate by  50 bps to 3% and continued to voice concerns over price  pressures emanating from food, industrial goods, and

services. ECB not only raised the GDP growth forecast for  2023 (1% vs 0.5% December estimate) but also revised  core inflation estimates to the upside (4.6% vs 4.2%  December estimate). 

Policy Divergence to Benefit Euro 

      • The Japanese yen appreciated 1% in the last month as  the possibility of aggressive Fed hikes in 2023 was taken  In his first conference as governor, Kazuo Ueda  On the data front, preliminary estimates saw CPI inflation   ease sharply to 6.9% y-o-y in March from 8.5% in February,although a sequential trend reported an uptick. Core inflation rose 5.7% y-o-y in March from 5.6% y-o-y in  February.  
        • We maintain an upside bias on the Euro over the coming month. Given that the ECB is expected to hike rates  a few more times (25 bps each in May and June) and by a higher quantum than the Fed, the monetary policy  divergence could stand to benefit the euro. 

        British Pound 

        • The British Pound appreciated nearly 3% in the last month,  on the back of waning dollar dominance and the likelihood  of more rate hikes in light of stubborn inflationary  pressures. 
        • At the March policy meeting, BOE hiked the policy rate by  25 bps to 4.25% as retail inflation spiked unexpectedly in  February. The MPC also acknowledged that growth was  stronger, and the labour market was hotter than previously  expected. Fiscal support from the measures announced in  the Spring Budget also led to an improved assessment of  the growth outlook. 
        • On the data front, both CPI and core CPI inflation remained  

        Improved Growth Prospects to Support GBP

      • elevated above consensus forecasts in March, with a robust  labour market contributing to price pressures. Wage growth  beat estimates rising by 6.6%, while the UK economy added  an above-forecast 169,000 jobs in the three-months to February. Meanwhile, Q4 2022 GDP came in better than-expected (0.6% y-o-y vs 0.2% consensus). On a positive note, the current account deficit narrowed  sharply to 3.3% of GDP in Q4 2022, from 4.2% of GDP in Q3. 
        • With an improvement in the economic outlook and fading concerns about the banking sector crisis in the US  and EU, the pound could continue benefitting from BOE’s need to hike interest rates further, especially as  tight labour markets are keeping wage inflation elevated. We see another 25 bps rate hike at the May MPC  meeting, with the possibility of more rate hikes arising only if inflation proves to be more persistent.  

        Japanese Yen

      • off the table. maintained a dovish stance, backing the ultra-loose  monetary policy until its 2% inflation target was met in a  stable and sustainable fashion. However, he expressed willingness to consider exit strategies after taking into  125 account both costs and benefits of a policy shift. 120
    • On the data front, CPI inflation dropped sharply in  115 

    February (3.3% y-o-y in February vs 4.3% prior)

  • core CPI Inflation came in line with expectations of 3.1%  from 4.2% a month ago. 
    • Meanwhile GDP grew by an annualised 0.1% in Q4 2022, slower than preliminary estimates of 0.6%, and  missing market expectations of a 0.8% rise. Going ahead, growth could slow further as elevated inflation dampens domestic consumption and a global slowdown takes a hit on exports. As a result, an abrupt end  to the yield curve control (YCC) is unlikely.
      • The yen could weaken in the run-up to the April 28 policy meeting–the first under Ueda, as the possibility  of a shift away from the current monetary policy at this meeting remains low. Moreover, with the Fed  expected to hike in May, the resultant widening of the US-Japan rate differential could weigh on the yen  over the coming month. 

      India Overview  

      • Rupee traded in a tight range over the last month, supported by weakness in the greenback, and the  narrowing of India’s current account deficit. 
      • After raising rates for six consecutive meetings by a total of 250 bps the MPC decided to leave the repo  rate unchanged at 6.50% in April. The stance was maintained at ‘withdrawal of accommodation’ while  reiterating that the door for future rate hikes remains open. RBI’s decision is likely to have been influenced  by prospects of moderating inflation in FY24 and the fact that the full effect of past rate hikes on the real  economy is yet to transpire. With risks to the growth outlook being largely balanced (GDP seen 6.1% in  FY24 as per CareEdge estimate), and inflation easing (5.2% by Q4 FY24) but remaining above the 4%  target, we do not foresee any rate hikes or rate cuts in 2023. Latest inflation prints have also supported  the view that inflation is on the downtrend, thanks to a favourable base and waning of pent-up demand.  However, elevated core inflation remains a concern. Retail inflation eased to a 15-month low of 5.7% in  March on the back of a favourable base and softening food inflation. Nonetheless, we remain wary about  upside risks to inflation emerging from weather-driven risks. So far, the IMD and Skymet have differing  predictions over monsoon. IMD has predicted normal monsoons but has highlighted that rain distribution  could be uneven, while Skymet has projected below-normal monsoons amidst the threat of El Nino. We  will have more clarity on how weather risks could pan out before we head into the next policy meeting in  June. Rising oil prices considering OPEC’s surprise production cut could also pose a risk to the inflation and  rupee outlook.  
      • The rupee took comfort from favourable external sector dynamics. The current account deficit (CAD)  narrowed to 2.1% of GDP in Q3 FY23 on the back of a smaller merchandise trade deficit as prices of global  commodities came off their highs during the period. Moreover, robust services exports and healthy  remittances helped cushion the impact of the merchandise trade gap. In Q3 FY23, receipts from services  exports grew by 24.5% y-o-y, driven mainly by exports of software services which recorded growth of  18.5% y-o-y. The upbeat services exports translated into a record-high services trade surplus of USD 38.7  billion. Exports of business services recorded growth of 38.4% y-o-y. The trade surplus in this category  was at an all-time high of USD 6 billion. Meanwhile, net private transfer receipts, which reflect the  remittances by Indians employed overseas, rose to USD 28.6 billion in Q3 FY23, higher by 33.5% y-o-y.  Looking ahead, we expect CAD to narrow to 2.1% of GDP in FY23 and further to 1.6% in FY24 as net  services receipt and remittances continue to pose as a bright spot. Capital flows would however remain  exposed to evolving global economic conditions. 
      • Overall, the rupee is likely to be supported by favourable external sector dynamics and further weakness  in the dollar. With the Fed likely to pause after a 25 bps rate hike in May, and RBI expected to keep rates  on hold this year, INR could continue to move in a tight range in the coming months, with any temporary  volatility being contained by RBI’s active presence and settle towards 81 levels by end-FY24.Indian Forex Market Chartbook Rupee Trades Rangebound FPI Flows Turn Positive for the Second Month

        The Indian rupee traded in a tight range over the last month, being relatively shielded from episodes of volatility emerging from the banking crisis in the West. Improving external sector dynamics and the gradual return of FPI  flows, have largely supported INR. 

        INR Flat Compared to Peers Over Last Month Rupee Declines in REER-Terms

        When compared to the performance of other Asian currencies, however, the rupee has underperformed several  peers despite a 2% fall in DXY. Receding global financial market volatility, signs of the US economy losing steam  and the peak Fed rate in sight has provided currencies like the Brazilian real and Mexican peso the opportunity to  benefit from attractive carry trades. Looking ahead, with Fed likely to start cutting rates before the RBI, the rupee  could also stand to benefit from attractive carry trades in FY24. Meanwhile, INR performance in REER terms shows  that it currently remains undervalued by over 3% from its 5-year average. 

      • FX Reserves rose by USD 17,507 million to USD 578.4  billion in March. However, the gain cannot be solely attributed to RBI’s purchase of dollars to build its  reserves. Gold, which accounts for around 8% of the total reserves, has appreciated by around 8% during the  month, which is also being reflected in the overall jump  in reserves. FX reserves continued to rise in the first  week of April as well, to USD 585 billion–levels last seen  in July 2022. RBI’s net outstanding forward purchase book nearly  doubled to USD 21 billion in January from a month ago. Given that FX reserves declined in February, with RBI  possibly defending USD/INR from breaching 83 levels, it is likely that RBI may have intervened in the forward  marketto mitigate the liquidity impact. As a result, RBI’s net forward dollar book could have declined in February.

        Forward Premia Rates Decline in Last 1 Month India-US Interest Rate Differential Narrows

      • Forward premia rates have been trending lower this month, in sync with the narrowing yield differential between  India and the US. The differential between India-US 10-year benchmark bond narrowed to 381 bps from as much  as 400 bps over the last one month, after an unexpected pause in the rate hike cycle by RBI saw India’s 10-year  benchmark bond yield ease to a four-month low of 7.21%.  Mar Rise in FX Reserves Highest Since Nov 2022 RBI Forward Dollar Book Up for 4th Month in Jan

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