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Pound's Rally Against the Rupee Intact, but Indian Authorities are Fighting Back

Indian Rupee and the economy

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- GBP/INR is pulling-back from overbought extremes 

- Indian authorities announce plan to fight devaluation of Rupee

- Expectations increase of a RBI rate hike

- Latest technical forecast for Pound vs. Rupee

GBP/INR is pulling back from two-year highs at 96.04 as India authorities grapple with markets to defend their currency's value.

Street protests at rising fuel costs have focused minds, and the authorities are desperate to prevent the Rupee from further depreciation. The weaker Rupee is partly responsible for pushing up inflation on imported goods, such as fuel.

The Pound has risen by over 20.8% against the Rupee since the March lows when it traded at 79.51 to the Pound. Against the Dollar, the Rupee is 13% lower, with the USD/INR exchange rate now at 72.37.

The fact that oil made a two year peak at around the same time as the Rupee hit a two-year trough is no coincidence: the two are highly negatively correlated due to India's dependence on imported oil.

The price of crude oil has more than doubled in the last two years rising from a low of 26.08 in 2016 to a recent 2-year peak of 75.24 in July.

When the price of oil rises India has to sell more Rupees to buy it and that weakens the currency further.

So what are the authorities doing about it?

Firstly, the Reserve Bank of India has intervened directly in the market to prop up the Rupee by using its large reserves to buy up Rupees and sell mostly Dollar's, with estimates that they have spent $20-25bn on trying to stem the currency's slide already.

Secondly, they are considering curbs on imports of non-essential items including gold and high-tech gadgets.

Thirdly, they are considering imposing duties on high-quality steel and certain agricultural commodities partly so as to also support domestic producers.

India recently became a net importer of steel after years of being a net exporter, and they don't like it.

Fourthly, the market expects the Reserve Bank of India (RBI) to start hiking interest rates at a more frequent pace, at least according to derivative pricing which provide a probability gauge of future changes in interest rates.

Over the past month, the three-month overnight indexed swap rate, for example, has risen 50 basis points to 7.0%, suggesting markets are pricing in a total 0.5% (probably in two 0.25% tranches) increase in RBI rates by December.

This week alone, it has risen five basis points, implying pricing for a 0.25% hike has increased by 20.0%.

Finally, the government have withdrawn a tax on Rupee-denominated Masala bonds in the hope it will make them more attractive to investors.

"Masala Bonds are rupee-denominated borrowings issued by Indian entities in overseas markets. Masala means spices and the term was used by International Finance Corporation (IFC) to popularise the culture and cuisine of India on foreign platforms. The objective of Masala Bonds is to fund infrastructure projects in India, fuel internal growth via borrowings and internationalise the Indian currency," say Business Today, offering a neat summary of the bond.

Much as central banks do not want to interfere in markets the Rupee has become locked into a kind of 'death spiral' which it probably needs help getting out of.

A weakening exchange rate normally solves the problem of a trade deficit by making imports increasingly affordable and therefore reducing demand for them whilst making exports more attractive to foreigners and increasing demand for them, however, when it is to pay for oil, which is an essential the country cannot function without, demand continues at a relatively steady level and the deficit simply widens.

The widening trade deficit is a major component of the current account which includes all cross-border transactions of any type.

India's current account deficit has widened mainly due to the increasing cost of oil. This is now seen as posing a risk by investors who have tended to pull-out of Indian assets as a result, which has further widened the current account deficit. It has also weakened the Rupee and contributed to its decline.

This is not to mention worsening sentiment caused by the Turkey and Argentine crises which has spread to other EMs like India. The worst hit are those with a deep current account deficit and high levels of Dollar- denominated debt. Tick, tick, India, which guess what? Has both the above risk indicators and is a further reason for the currency's decline.

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Where will GBP/INR go next?

From a fundamental perspective there is no way of knowing for sure where the price of oil will go next and the Rupee's underlying current will probably be determined by that more than any other factor.

The RBI has high reserves of $420bn with which to fight the Rupee's decline so which is a lot - for now at least, but given an estimated $20-25bn have already been spent with little demonstrable effect, it's clear it doesn't have endless ammunition either.

A further strategy from the government could be to do what it did during the last currency crisis and incentivise the purchase of Masala bonds to wealthy expats, which appeared to have a strong pickup and demonstrable impact on the Rupee.

From a technical perspective, GBP/INR has come off its day's highs, probably as a result of the measures enacted by the central bank and government, and yet overall the Rupee remains locked in a downtrend (uptrend for GBP/INR) with no let up on the horizon.

GBP to INR Sept 19

Currently there are no signs the uptrend (downtrend for the Rupee) is reversing, and as such it is seen as marginally more biased to continue than not.

From a technical perspective, if Wednesday ends below the midpoint of the previous day and Thursday ends lower too that will post a bearish 'dark cloud cover' Japanese candlestick pattern which will bode ill for the pair in the short-term and provide at least some evidence of a reversal.

The RSI momentum indicator in the bottom pane is also looking vulnerable to more downside too, after forming a double top pattern in the overbought zone.

A close below 69 (for the RSI) will signal the double top is breaking lower and more downside is probably expected from the underlying asset too. A move from overbought zone back down is traditionally a signal to short the asset.

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Secure Sterling's strength against the Rupee: Get up to 5% more foreign exchange for international payments by using a specialist provider to get closer to the real market rate and avoid the gaping spreads charged by your bank when providing currency. Learn more here