(Bloomberg) -- The Reserve Bank of India will raise interest rates this year, which will help reverse the declines that have made the rupee Asia’s second-worst performer, according to Capital Economics Ltd.
The rupee will strengthen to as much as 62 per dollar by the end of 2018, said Shilan Shah, a Singapore-based India economist. The bullish forecast comes amid a spate of cuts by analysts from banks including Standard Chartered Plc as rising oil prices and slowing capital inflows sour sentiment.
“We expect a hike in the policy rate in India, which will widen the interest-rate differential between India and its peers, including the U.S.,” Shah said. “We do also expect further tightening in the U.S. but this has already been priced into markets.”
The RBI may tighten policy as early as October, Shah said, with the main repurchase rate rising 75 basis points over the next year to 6.75 percent. The central bank brought forward rate-hike expectations last week by releasing unexpectedly hawkish minutes of its last meeting.
While higher borrowing costs tend to support the currency, that correlation doesn’t typically work in India, where foreign inflows into equities -- an asset class sensitive to rate cuts -- matter more. Bond investments by global funds are subject to limits, though there have been moves recently to ease the caps.
Australia & New Zealand Banking Group Ltd. and Malayan Banking Bhd. both said that a hawkish RBI doesn’t bode well for the rupee. The currency dropped to the weakest level in more than 13 months on Wednesday.
“The possibility of an earlier or additional hike will be negative for INR,” ANZ analysts including Khoon Goh wrote in a note Tuesday.
India imports two-thirds of its crude needs and the spurt in oil prices has coincided with the slowdown in capital inflows. Foreigners have pulled $1.4 billion from its debt so far in 2018 amid hardening global yields, and this month turned net sellers of local shares.
Elevated energy costs are a threat to the rupee, though Capital Economics expects crude to drop to $65 a barrel by year-end, Shah said.
“These are concerns, but they will be allayed by tighter policy,” he said.
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