Omicron variant, Fed's rate hikes to decide the direction of Indian rupee in 2022

Despite dollar inflows during the initial part of 2021 and the Reserve Bank of India's (RBI) policy of amassing foreign exchange reserves by buying dollars in the market, the Indian rupee depreciated against the US dollar from 72 to 76 during the year, before settling at 75.16 towards the end of 2021. 

The dollar still looks strong with better economic growth and jobs data from the US, while Europe is still struggling with Omicron concerns, says Anil Kumar Bhansali, Head of Treasury at Finrex Treasury Advisors. "The rupee has regained partly from a low of 76.30 to 75.30 as RBI sold dollars, but the trade deficit, Fed tapering, and Omicron concerns could again be a major impediment in its strength," predicts Bhansali.

Clearly, the global factors are likely to take centre stage in 2022 with interest rates moving up from UK to Mexico to Russia. Most of the central banks have already hinted about inflationary pressure and the likely withdrawal of easy monetary policy. The US Federal Reserve has already started its exit from the easy monetary policy by reducing the monthly bond purchases. The next in line will be interest rate hikes from Fed in 2022.  

"Global central banks are gearing up for policy normalisation, contrary to the accommodative stance of the RBI, which has also led to money outflow from the emerging markets. Monetary policy divergence has induced a sharp rally in the greenback, leading to the depreciation of the Indian rupee," says Sugandha Sachdeva, VP-Commodity & Currency Research at Religare Broking Ltd.

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Sachdeva also warns that oil demand is projected to reach pre-pandemic levels by the end of 2022, which can be a major headwind for the rupee in the second half of the year.

There is also pressure from the domestic market. The equity market seems to be fairly valued, with foreign investors booking profits. Experts suggests that higher input costs and likely increase in interest costs will impact the margins going forward.  

"If rupee liquidity rises in the market, the domestic currency's value is put under pressure. This weakness will be exacerbated by a strengthening dollar. As the supply of the local unit grows, the value of the rupee against the dollar will decrease. The RBI is also signaling that interest rates would remain low for a long time by pumping ample liquidity into the banking system," says Kshitij Purohit, Lead Commodities and Currencies at CapitalVia Global Research Limited.

In addition, the RBI has clearly stated that it will continue with its accommodative stance. "This means that despite rising inflation, the monetary policy committee (MPC) has no plans to raise key policy rates. Because now is the time for growth," adds Purohit.
 
Lower interest rates in India and higher rates globally would result in flight of foreign capital from the domestic market for higher returns. 

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