The Indian rupee had strengthened considerably in the boom period of 2005 to 2007, when it appreciated to 38.19 levels against the US dollar. But post 2008, when dollars started flowing out of the country, the rupee started its downward journey. In 2013, rupee touched a low of 68.69 against the US dollar.
That was the time Raghuram Rajan was brought in as RBI Governor. Rajan's initiatives, such as raising dollar deposits of over $30 billion, halted the rupee depreciation.
In fact, it appreciated briefly to 58 levels. But it has largely remained range bound since then between 66 to 68 levels. This week, the rupee has made some smart gains by closing at a 16-month high of 65.73 levels. While there are four major contributors to the rupee appreciation, it is too early to say that the currency is on its way towards a long 'strengthening cycle'.
i) Stability of government
The central government, which enjoyed a majority in the lower house, now looks more stronger and stable. The recent successes in the state elections, including Uttar Pradesh, has given a boost to the BJP-led NDA government. The government will now soon have the numbers to go for bold reforms without any disruption in Parliament. Experts say the conditions are now right for more stable dollar inflows via the FDI route.
ii) Fund flow into Indian equity markets
Foreign funds are back in the Indian equity market. GDP growth looks intact post demonetisation even though most analysts had expected the economy to take a knock. The latest numbers released by the CSO doesn't show major losses, though many experts says it is too early to pass a judgment. The corporate sector is also on the path of de-leveraging and huge investment in the rural economy and infrastructure is going to boost consumption. The fiscal deficit, too, is manageable.
iii) RBI's neutral stance on policy rates
The RBI's neutral stance on policy rates has been a huge relief for currency traders. The easing of interest rate cycle clearly shrinks the arbitrage of rates between India and global markets. In fact, inflation numbers are also inching up, which reduces scope for further cuts going forward. This will boost the flow of funds into India in debt and other fixed income securities. But there are also concerns of Fed hiking rates. If it hikes rates in 2017 and Indian rates remain unchanged, funds could flow back to the US.
iv) Weakening dollar
US President Donald Trump has inherited an economy that was recovering fast, short term interest rates were set to go up and dollar, too, was strengthening against the global currencies.
There was a huge expectations from new President Trump to give economy a push with his new policies/ ideas. But there is now a fear of political uncertainty and protectionism which could push the dollar down. This is good news for the Indian rupee. But one just can't discount Trump who could sprang a surprise by tax cuts and other fiscal policies to boost business.