Is It Time to Stop Fighting Mumbai?

The rupee and Indian shares responded positively to new central bank measures to steady the currency, which has fallen more than 7% over the past three months and is the worst performing Asian currency. While recognizing the positive short term impact, we remain concerned that the domestic and international environment may not be conducive for a sustained recovery.

Yet much of India's bad news already seems discounted. S&P cut the outlook for on its BBB- rating last month. The trade deficit peaked in January and had fallen for three months through April. The drop in the price of oil should reduce pressure on both the trade front and inflation.

Officials have been slowly ratcheting up its rupee defense. Today's measures require corporations to repatriate half of their overseas earnings. Previously they did not have to repatriate any. This follows the recent measure to increase the rate for foreign deposits. The central bank is also believed to have stepped up its intervention operations in recent days.

In March the government doubled (to 4%) that tax on bullion imports and this helped produce the desirable effect: Gold and silver imports fell by a third in April. This helped narrow the trade deficit and indirectly may be considered another part of the rupee support program.

Technical factors are also arguably turning more positive. The dollar's advance today stopped short of last Friday's high near INR53.9225. This is potentially setting up a double top on the charts. A break of INR52.67, Tuesday's low is needed to confirm this. In addition, the momentum indicators a warning of a dollar-bearish divergence. Given the dollar's strong rally since early March, short-term market positioning and momentum players are most likely long.

The importance of the price action is it reinforces the resistance and it is clearer where the risk is on establishing short dollar positions. At the very least, it warns those still fighting Mumbai to be careful and that stops should be raise to that INR53.67 area or the 20-day moving average, which comes in near there (~INR52.50). If the bad news has been discounted, and market positioning is stretched there is potential toward INR50.80.