The Indian Rupee stayed in a fairly tight range during the month of September as a number of factors worked in its favour to keep the RBI busy in preventing a runaway appreciation of the currency. Touching 72.85 briefly on 1st September after the shock withdrawal of RBI support for the USD at 74.80 levels through July and August the dollar received support for the month of September as the RBI continued to add to its foreign exchange reserves

1. INR Outlook October 2020
The Indian Rupee stayed in a fairly tight range during the month of September as a number of factors
worked in its favour to keep the RBI busy in preventing a runaway appreciation of the currency.
Touching 72.85 briefly on 1st September after the shock withdrawal of RBI support for the USD at
74.80 levels through July and August the dollar received support for
the month of September as the RBI continued to add to its foreign exchange reserves
Big-ticket inflows- mainly from the Reliance group, a weak USD globally, the fall in oil demand
domestically, all contributed to a strengthening INR. The latest numbers show that India recorded its
second consecutive quarter of a current account surplus in the July to September period. This was
again achieved through a sharper fall in imports over declining exports and led to the largest current
account surplus in Indian history. In Q1 we saw a bare surplus of USD 0.6 billion but this quarter saw
that balloon out to USD 19.8 billion translating to a current account surplus of 3.9% compared to 0.1%
the previous quarter. Coincidentally, the FX reserves also shot up by USD 19.8 billion in the same
period versus a rise of USD 14 billion the previous three months.
Hidden in these headline figures, of course, is the decline in remittances (down 8.7%), Net FDI (minus
USD 0.4 billion versus positive USD 4.8 billion earlier) and even Net Portfolio Investment (down USD
4.2 billion from earlier). But the combination of a lower ECB outflow by USD 4.9 billion over the
previous period and a fall in the merchandise trade deficit of USD 10 billion gave a rosier picture of
the state of affairs than is merited.
The fall in volumes on both sides is indicative of lower commercial activity. So, whilst this gives some
overall relief from an external balance perspective it cannot take away from the disastrous shrinkage
of overall economic output. The only bright spot in this is the fact that the Current Account Surplus
allows the government to borrow more (domestically in INR) without disrupting the yield curve as
much as one would expect. There is- after all, an increase in savings implied by the surplus.

2. The converse of the Indian economy recording a surplus in the Current Account is the story of the US
economy and what we can expect going forward for the US Dollar. Continuing my earlier analysis of
the beginnings of a long-term decline in the USD we can see the factors that will contribute to the fall.
Firstly, the Real Effective Exchange rate of the USD against a trade-weighted basket of currencies (the
favourite measuring tool of the RBI, by the way) shows that it has appreciated over 34% since 2011
even accounting for the recent fall this preceding quarter. This appreciation has not been due to an
increase in productivity or growth and- given the other factors to be mentioned, is likely to be eroded
in the next few years.
Secondly, the US has been witnessing a collapse in Net domestic Savings. The collapse has been the
sharpest since 1947 and is likely to continue. The net national savings rate- which is a depreciation
adjusted sum of the savings by households, businesses and the government, has gone to -1% this last
quarter- a level not seen since 2008/9 where it recorded 7 consecutive quarters at an average of
-1.7%. With the stimulus cheques in hand personal savings shot up to 33.7% in April before sliding
back to -17.8% in July and will fall further as no further payments come in. But the government has
seen a massive widening of the federal deficit to USD 5.7 trillion- more than offsetting the USD 3.1
trillion in personal savings. The Federal budget is expected to have a deficit equivalent to 16% of the
GDP in 2020. The upshot? This savings shortfall has to be made up by external borrowing when the
current account deficit is at -3.5% of GDP. The expectation- according to Stephen Roach of Yale
University, is for the net national saving to hit between 5 and 10% of national Income and the current
account deficit to cross the 6.3% of GDP which it last touched at the time of the financial crisis. And
what tool could the Fed use to prevent a run on the currency? The one tool which they have just said
they will leave in the shed: interest rates. They have announced their intention of not touching rates
until inflation averages 2%.
The consequences are already being felt. The USD now comprises less of the foreign exchange
reserves of most countries and that trend is expected to continue. The loss of confidence in the US is
translating directly into a shift towards the Euro and the Yuan as viable alternatives in reserve
portfolios. The Germans may not be overly enthused about a strengthening Euro but the trend has
begun and may accelerate despite their sub-zero interest rates simply because of the negativity
around the US.
The interesting thing then is which country will see a depreciating currency between the USD and the
INR: the US with its deteriorating current account deficits arising out of a collapsing net national
savings rate and an overvalued REER or India with its collapsing economy and barely investment grade
ratings debt problem? The answer is likely to be that the US will devalue against a basket of
currencies- including the INR, but the pace of devaluation against the rupee will be a controlled
descent by the RBI who will use the opportunity to accumulate foreign exchange reserves and release
unsterilised rupees into the wild. This tactic would allow the government to borrow a larger than
expected sum (despite having just announced an unchanged borrowing programme for the full
financial year) without upsetting the yield curve.
The recent trend of the currency pair suggests that this is already underway as we see the RBI support
certain levels for a while and then drop their buying levels suddenly. They may have already
abandoned their support of the 73.50 level. Last month 72.00 was suggested as a possible target and
that may be applicable this month. Above 74.00 is now out of the picture.