After a strong 6% appreciation against the ‘US Dollar’ in 2017, Rupee value has depreciated by about 4.5% thus far in 2018.
The present slide is on account of rising oil prices and increasing yield significant FII (Foreign institutional Investors) outflows.
Why are FII’s pulling out?
The increased demand for US Dollar is nudging out FIIs to pull out from Indian stock markets and move to destinations of better returns.
While as much as $30 billion was pumped into Indian debt and equity in 2017 by FIIs, they’ve currently pulled out a net of $2.3 billion in March alone.
US Federal Reserve has signalled last month that it is on course to raise the policy rate at least two more times in 2018 (curtailment of Dollar supply).
This has also fed into investor expectations, and precipitated in a 3% rise of yield for 10 year benchmark US Treasury bonds, for the 1st time since 2014.
What are the trends in global oil prices?
Global oil prices are continuing a steady climb on the back of tight output controls marshalled by the OPEC.
Notably, Saudi Arabia, the world’s largest oil producer, has stated that it is eyeing oil prices in the vicinity of $80 a barrel to meets its budgetary demands.
Tensions between Iran and US over the Nuclear Deal pullout would also most certainly prevent any softening of oil prices.
Even a possible increase in US shale oil output has been estimated to be insufficient to offset the expected price spike.
What are the possible impacts for Indian Rupee?
Rupee is particularly vulnerable to mounting oil costs given the economy’s extremely high dependence on crude imports to meet energy needs.
Increase in oil prices has bloated India’s crude import bill and widened the trade deficit, which for March 2018 alone was about $13.69 billion.
Additionally, the pullout of FII’s has also increased rupee supply in the international currency market.
All these factors has led to considerable depreciation, which needs to be moderated in order to ease the pressure on import bills.
In this backdrop, RBI’s massive $423.6 billion in forex reserves does provides some respite, as this might help in dampening Rupee volatility.
The Bond Market Concept
What does Bonds Yield mean?
Bonds are loan instruments and hence are a safer and “Bond Yield” is the percentage of return that an investor in bonds derives per annum.
Let us consider a bond (that is issued by a borrower) at a face value of Rs.1000, with a rate of interest of 10% on the Face Value.
For the initial investor, the bond yields Rs.100 for his investment of Rs. 1000, which implies his yield is 10%.
When bonds are sold in the secondary market, bond yield for subsequent investor might vary depending on the sale price (Real Bond Value).
But irrespective of the Real Bond Value, interest rates are always based on the ‘Face Value’ as determined by the primary borrower.
If Real Bond Value (sale price) increases over time, then bond yield decreases, as the interest amount will remain the same despite a higher investment.
Conversely, if Real Bond Value decreases, then yield increases as a lower sum would be able to get the same interest amount.
Hence, Bond Yield and Bond Value hold an inverse relation.
What factors influence Bond Yield?
Market interest rates (banks) are the primary influencers of Bond markets as they are competing investment options for people.
An increase in interest rates would reduce the demand for low yielding bonds as people would want to put their money where returns are higher.
To sell Bonds when market rates are high, a Bond holder will have to ‘lower his/her bond value’ to ‘increase bond yield and attract investors’.
It is to be noted that money is in demand when market interest rates are high.
Currently, this is what is happening in the US Economy as the US Federal Reserves has increased interest rates and pledged further increases.
Conversely, a decrease in market interest rates would make bonds attractive for investment and hence lead to a spike in Bond Value due to demand.
Also, Bonds are a safer investment option than others, and hence any economic uncertainty would drive investors to buy bonds.
These factors would create a spike in bond demand, which would thereby increase Bond Value and reduce Bond Yield.
