Analysts started the year expecting the rupee to beat Asian peers. But so far, the Indian currency has been the second worst performer in the region.
On Friday, the Rupee closed at 66.11 compared to its previous close of 65.80. The rupee has weakened 3.3 percent against the dollar in 2018, faring better than just the Philippine Peso. April alone contributed a third of that depreciation, bringing the rupee to its weakest in a year. Seasonality suggests more pain. In four of the last five years, the Indian currency has weakened in May and June.
The question is whether this weakness is a short term phenomenon? Or will the currency depreciate in 2018 after appreciating nearly 6 percent in 2017?
Currencies are notoriously tough to predict but, experts say, the dice is getting loaded against the Indian rupee. For now.
Crude Oil Concerns
Not surprisingly, one key determinant for the direction of the Rupee will be oil prices. Crude rose to $74 a barrel amid reports of a sharp fall in U.S. inventories coupled with Middle East tensions. Asia’s third-largest economy imports about 80 percent of the oil it consumes.
Costlier oil will make the current account deficit stick at a relatively high 1.9 per cent of the GDP in the ongoing financial year, Bank of America Merrill Lynch said in a note to clients.
Kotak Economic Research fears that the current account deficit may be even higher at 2.4 percent of GDP, assuming that crude prices average around $65 a barrel. In that scenario, Kotak expects the rupee to trade in a 65-67.50 range in 2018-19.
Sajal Gupta, head of foreign exchange and rates at Edelweiss Securities, in Mumbai shares the concern that rising oil prices could worsen the nation’s finances.“Crude staying above $70 a barrel is a major concern and given that we are in an election year, we won’t see more major reform steps coming from the government,” she said. Gupta expects the rupee to weaken to $66.20 a dollar in the near term. “If breached, we could see 66.50 levels.”
Weakness In Portfolio Flows
Along with a wider current account deficit, India has also seen a slowing in portfolio flows. This means that the balance of payments will also deteriorate. The balance of payments is an account of the country’s monetary transactions with the rest of the world. The current account is one part of it and the capital account, which includes portfolio flows, is another part.
So far in 2018, Indian equity markets have seen an inflow of Rs 9800 crore while debt markets have seen an outflow of Rs 4300 crore, shows data from the National Securities Depository Limited.
We believe there are enough macro uncertainties, primarily on the domestic front (but external as well), that will put a strain on the balance of payments (BoP) picture of India and prevent a meaningful rally in Indian assets. On BoP, we see sources of weakness from both current account and portfolio flowsBank of America-Merrill Lynch
The situation could turn, for the better or for the worse, if the global policy and monetary policy environment changes. Analysts are watching for two things. Do the trade tensions worsen? And does the normalisation of monetary policy in the US go smoothly?
Escalating tensions over trade tariffs between the U.S. and China have hit global stocks and several major emerging market currencies on concerns that the world’s two largest economies could deal a blow to the global economy. Kotak included the possibility of a trade showdown resulting in a currency war among its “unknowns” that could impact the rupee.
U.S. President Donald Trump has already said that Russia and China are playing the currency devaluation game. And the U.S. added India to its currency watchlist.
How calmly global markets respond to the U.S. Federal Reserve plan to continue raising rates, will also determine portfolio flows over the rest of the year. Even if global markets remain steady, higher rates in the U.S. may reduce the attractiveness of Indian assets, particularly bonds.
The Federal Reserve has been increasing rates in the U.S., offering higher returns to investors in a lower risk market, Gupta of Edelweiss Securities said. This may weigh on the rupee in the second half of the year, she added.
Will The RBI Intervene?
The Reserve Bank of India, sitting on $426 billion in foreign exchange reserves, can easily step in to sell dollars and support the rupee. But will it?
The RBI is holding on to protect the currency, said Jamal Mecklai, chief executive officer of Mecklai Financial Services Ltd. “Immediate resistance for the rupee is around 66.20-22 levels and we expect it to remain stable around 66 levels in the near-term.”
Gupta is hopeful that the RBI will intervene given the current volatility in the rupee. In case it doesn’t, the rupee could depreciate to 67.50 a dollar by year-end. The probability of that happening is 20 percent, according to the brokerage, as macros still remain intact with a positive monsoon forecast in the first half.
However, Bank of America-Merrill Lynch says RBI intervention may be limited.
In our opinion, the RBI will be amenable to letting the rupee weaken. This is because central banks are generally willing to accommodate movements in their currencies if the change in the BoP picture is coming from current account rather than portfolio account.Bank of America-Merrill Lynch