Last week, the rupee recorded its strongest weekly performance since March, gaining 2% after the Reserve Bank of India (RBI) introduced a series of measures to support the domestic currency. The rupee closed at 94.96 on Friday.
The RBI has made it more expensive for importers to hedge future current-account payments and increased the cost for banks purchasing foreign currency for certain transactions. The central bank has also opened a dedicated window to supply state-run oil companies with dollars directly from its foreign-exchange reserves.
The combined effect of these measures, expectations of further action and the RBI's market interventions is expected to provide support to the rupee. Traders anticipate the currency will trade within a range of 94 to 95.50 in the near term.
Indian financial markets will remain closed on Tuesday for a local holiday. During the shortened trading week, investors are expected to monitor developments in the Middle East and their potential impact on crude oil prices and foreign portfolio flows into Indian assets.
Brent crude prices touched 0 a barrel on Friday for the first time since May, adding to concerns surrounding the outlook for the rupee. Meanwhile, uncertainty over global investments in artificial intelligence (AI) firms is also expected to influence the foreign exchange market by affecting equity and debt flows.
"Heavily overweight positioning leaves the USD vulnerable to a reversal when sentiment towards AI deteriorates," MUFG said in a note.
Indian government bonds could continue to experience mild selling pressure as concerns over a larger interest rate hike weigh on investor sentiment. Traders expect the benchmark 10-year government bond yield to move within a range of 7.32% to 7.42%, with crude oil prices and any additional RBI measures remaining key factors to watch.
India's benchmark 10-year bond yield recorded its ninth consecutive weekly increase, closing at 7.3789% on Friday, up 8 basis points during the week. According to data compiled by LSEG, the yield had risen 54 basis points over the preceding eight weeks, extending its longest-ever run of weekly increases.
Market sentiment has remained negative since the RBI raised the policy repo rate and changed its stance. The concerns were reinforced by hawkish comments from Governor Sanjay Malhotra during a media interview.
Krishna Bhimavarapu, Asia-Pacific economist at State Street Investment Management, said, "We would not characterise the RBI as significantly behind the curve, but inflation risks remain tilted to the upside. A cumulative 100 bps of tightening by June would help the RBI stay ahead of emerging price pressures while preserving its inflation-fighting credibility."
Following the central bank's comments, expectations of a 50-basis-point rate hike in December have increased. The RBI is expected to use interest rates as a defence mechanism to protect the domestic currency.
Foreign investors are also expected to remain cautious after selling Indian assets over the past few days. With crude oil prices, global investment sentiment, currency-support measures and interest rate expectations influencing market direction, the rupee and government bond yields are likely to remain in focus during the shortened trading week.
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