Rupee, bonds steady as all eyes on RBI policy

At 11: 00 hours (IST), the Indian currency quoted at 74.1550 to the US dollar against 74.1150 on Friday. The local unit opened at 74.1500 on Monday.

Over the past month, the rupee has shed around 1.5% against the US dollar as the US Federal Reserve’s guidance for normalisation of its monetary policy –accompanied by a timeline for a rollback of quantitative easing—has led to a global strengthening of the greenback.

A tighter monetary policy in the world’s largest economy would likely lead to a reversal of the extraordinary overseas inflows that emerging markets such as India have enjoyed ever since the Fed unleashed a deluge of liquidity in the global banking system to tackle the Covid-19 crisis.

Last week, the rupee touched a one-month low against the dollar as the Dollar Index touched the psychologically significant level of 94.50. The Index, which measures the US currency against six major currencies, last quoted at 94.03.

Investors also kept to the sidelines ahead of the Reserve Bank of India’s monetary policy statement on Friday.

Speculation is rife that the central bank could announce a hike in the reverse repo rate, which at present represents the overnight cost of funds for money markets.

Unlike developed economies where higher interest rates typically lead to a stronger currency, the Indian rupee gains more from interest rate cuts as these lead to greater inflows into equity markets.

Government bonds were also steady ahead of the crucial policy statement on Friday, with yield on the 10-year benchmark 6.10%, 2031 paper last at 6.25%, one basis point higher than previous close. Bond prices and yields move inversely.

If the RBI does indeed signal its intention to start lifting interest rates, the sovereign yield curve would see realignment to the expected cost of funds, with most dealers expecting short-term papers to see at least a 10-15 basis-point rise in yields.

A recent sharp rise in cutoff yields on Treasury Bills –which are very closely aligned to interest rate expectations and liquidity conditions-, is testament to the market’s trepidation about interest rates rising.