The rupeeâ€™s sharpest rally in almost a year is giving Indiaâ€™s central bank scope to take out an insurance policy for what could be a tumultuous 2017.
A resumption of stock and bond inflows and a budget viewed as fiscally prudent and pro-growth spurred a 1.9 percent gain against the dollar in the last three weeks, the best performance in Asia. The Reserve Bank of India (RBI) is responding by buying dollars to bolster its foreign-exchange reserves. It added $1.6 billion to its stockpile in the week through Feb. 3, the most since early September.
One of the worldâ€™s fastest growth rates, slowing inflation and a domestic market of 1.3 billion people has made India an attractive hedge against a possible rise in trade protectionism after President Donald Trumpâ€™s surprise U.S. election win. Still, the Asian nation wouldnâ€™t be immune to an external shock that causes investors to sour on developing-nation assets.
â€œThese rupee levels provide a great opportunity to buy dollars and build reserves just in case depreciating rupee pressures return,â€ said Viraj Patel, a foreign-exchange strategist at ING Groep NV in London. â€œIn a year when globalization and free trade will come under intense scrutiny,â€ Indiaâ€™s focus on tackling domestic problems rather than chasing export-led growth should prove beneficial, he said.
The rupee has declined 0.1 percent this week to 66.97 a dollar as of 9:13 a.m. in Mumbai. The currencyâ€™s three-week rally was the biggest increase over such a period since March 11, 2016.
The RBI is unlikely to tolerate the rupee gaining beyond 66.5 a dollar, said Patel, adding that he expected dollar strength to return with â€œa vengeanceâ€ in the next few weeks. The currency would probably weaken toward 68.5 this quarter and then rebound to settle between 66 and 67, he said.
Indiaâ€™s foreign-exchange reserves increased 0.4 percent to $363 billion in the week through Feb. 3, according to data released Friday. That was the fourth weekly advance in a row, the longest such run since August.
Based on the International Monetary Fundâ€™s methodology for calculating reserves adequacy for emerging-market economies, a range of $215 to $325 billion is enough for India, said Khoon Goh, head of Asia research at Australia & New Zealand Banking Group Ltd. in Singapore.
â€œIndiaâ€™s level of FX reserves is more than adequate at present,â€ he said. Although, â€œyou definitely want to rebuild when times are good and you have inflows coming in, and not be afraid to use them when you have extreme volatility on the other side.â€
The rupee and Indonesiaâ€™s rupiah are ANZâ€™s favorite emerging Asian currencies due to the countriesâ€™ high bond yields and their governmentsâ€™ commitment to fiscal discipline and reform momentum, said Goh.
Indiaâ€™s strong macroeconomic fundamentals, the rupeeâ€™s attractiveness as a carry-trade currency and the fact that the nationâ€™s exports to the U.S. account for only 2 percent of its GDP, augur well for the exchange rate, said Amit Agrawal, a foreign-exchange strategist at Societe Generale SA in Bengaluru.
â€œWe expect the RBI to continue its asymmetrical intervention policy to manage FX volatility with a preference to buy dollars,â€ he said.