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Why 55-60 to the dollar may be the new normal for rupee

The USD-INR (dollar-rupee) pair is expected to hover around the 60 level for some time unless there is a sudden surge in the US dollar index. The INR has been relatively weaker than the the dollar index as both have been falling instead of moving inversely.

The dollar index measures the US dollar against a basket of six major currencies. These include the euro, the Japanese yen, the Swiss franc, the pound sterling, the Swedish krona and the Canadian dollar. Hence when the index falls against major currencies one would expect the dollar to drop against the rupee too. But this has not happened with INR falling against the dollar.

Now the US dollar index has reached support, as shown by the white horizontal lines on the chart. (Click here for the Dollar index chart) If it indeed catches a bounce, we could see further downward pressure on the INR. On the other hand, a drop in the US dollar index does not seem to help INR, so the Indian currency seems to be marching to its own gloomy beat.

On 25 May, we had mentioned that if the INR breached the 56.11 level it could go to its previous all-time high of around 57 and beyond that it could fall drastically as there was no support. That is exactly what happened with the rupee nearing the 59 level yesterday. However, it seems that the Reserve Bank of India intervened in the markets to buy the INR as the Indian currency rallied 60 paise in just one hour to 58.30 from 58.90. Such rapid movements in the currency markets generally indicate central bank intervention or short-covering.

Andrew Middleton/Flickr

Andrew Middleton/Flickr

So what could happen to the the INR? We believe that 60 is a psychological support level of the currency. If the rupee breaches that level, it will lead to a loss of confidence in the INR and the descent could be very rapid. We believe that the Reserve Bank too would not like the INR to fall below 60. The continuous fall of the INR results in imported inflation and inflation is the what the Reserve Bank has been trying to fight for such a long time. It is ironic that the INR does not appreciate despite the huge interest rate premium it has over the other major currencies. It reflects the inherent weakness created in the economy by the large scale deficit financing of the government.

We see major resistance for the INR at the 54 to 54.80 level. If this level is breached in the future we could see a further rally in the Indian currency. Traders could look for a trading range for 55 to 60 if the 60 level is not breached.

The intervention by the Reserve Bank is nothing but a band aid to the problems of the rupee. As a general rule interventions in the market rarely change the long-term trend. Take a look at the recent intervention by the Japanese central bank to depreciate the yen. After depreciating for a few weeks, the yen is now back to going up again against the US dollar. So we'd not give much weight to the intervention by the Reserve Bank of India, unless we see structural reforms in the system that forces the Indian government to live within its means and lower taxes to stimulate the economy.

A quick look at the INR versus other major currencies too shows a gloomy picture. Against the euro the INR went to a new low. From a level of 70 in April the EUR-INR pair fell to 78, more than a 10 percent fall which is big in the currency markets. The pair could go to the next psychological level of 80. The Japanese yen rose from a low of 0.53 to more than 0.60 against the INR. The GBP-INR pair went from 82 in April to 90 now. Both the pairs could consolidate for some time. If the GBP-INR pair breaches 90, it could go all the way to 100.

The author is Editor