Rupee hits two-month low on outflows, investors await RBI outcome with hike priced in

The Indian rupee declined to its weakest level in over two months on Tuesday, hit by outflows from local equities, while traders turned their focus to the Reserve Bank of India's monetary policy decision on Wednesday where a hike is widely anticipated.

Dollar sales from state-run banks, most likely on behalf of the RBI, helped limit the rupee's fall. The currency ended the session at 96.42, down 0.1% from its previous close.

The central bank also likely conducted dollar-rupee sell/buy swaps to drain excess rupee liquidity from the banking system, traders said. It has been conducting such FX swaps, open market bond sales and reverse repo transactions to absorb excess cash in the weeks leading up to Wednesday's policy decision.

About 60% of the 61 economists polled by Reuters have pencilled in a 25 basis point hike, while swap markets have priced in a modest possibility of a larger-than-expected 50-basis-point rate increase.

The RBI last raised rates in February 2023 and in addition to its rate decision, investors will pay close attention to policymakers' remarks for cues on the future trajectory of benchmark rates as Asia's third-largest economy navigates an adverse external scenario.

"We believe a combination of a 25 bps hike with hawkish guidance, tactical OMO sales and sell-buy FX swaps would provide some near-term protection for the rupee and thereby allow the pace of monetary tightening to be geared to domestic growth-inflation dynamics," analysts at J.P. Morgan said in a note.

A rate hike would aid the rupee by raising the cost of betting against the currency at a time when short positions on it have remained firm due to lingering energy supply risks from conflict in the Middle East.

Asian currencies were mostly rangebound while the dollar index treaded water around the 102 handle.
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