Where is the Indian Rupee headed? (v2)

Posted by USFC Team on Aug 22, 2018 5:52:21 AM

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After witnessing unprecedented stability over the past couple of years, the INR has turned highly volatile and, in recent months, seems to have consistently lost value against the US Dollar (USD). A key reason for this can be attributed to Foreign Portfolio Investment (FPI) outflows.  In the current financial year (FY 18-19) till date, FPIs have withdrawn INR 62,700 crores from Indian markets (roughly USD 9.5 bn). Fixed income witnessed Foreign Institutional Investor (FII) outflows of INR 42,000 crores accounting for 2/3rd of the entire outflow while equities saw outflows of INR 20,700 crores.

Rising US Treasury Yields and worsening Indian fiscal outlook due to a surge in Crude prices seem to be the primary reason for a spike in FII outflows. This has led to a significant surge in Indian sovereign yields. Both of these factors, coupled with the possibility of higher government spending ahead of the national elections in India, point toward FII outflows from Indian fixed income markets until the end of the current fiscal year.

Also, a rise in developed markets sovereign yields, especially US treasury yields, has led to a surge in risk premiums across asset classes, including emerging markets. Indian equities, specifically, may continue to grapple with global portfolio repositionings and re-ratings leading to consistent FPI outflows.

A surge in Crude prices, along with a shocking increase in electronics imports (which displaced Gold as India’s second largest import item), point toward a worrying rise in the Current Account Deficit. The twin deficits are expected to keep the INR under pressure even as a minor trade skirmish unfolds between the US and India.

Murmurs on demonetization affecting production and supply, especially from India’s SME and MSME, means that surging USD-INR rates are not helping many exporters as well. This, specifically, can have cataclysmic effects as the SME and MSME sectors contribute nearly 45% to India’s manufacturing and exports.

Overall, the recent USD-INR moves seem to adhere to the age-old economic theory that a currency with higher inflation has to weaken against a currency with lower inflation even though global portfolio and capital flows may delay the inevitable.

We expect the unprecedented volatility in INR to stabilize and hopefully recede towards 66.5-67.5 over the near future. However, we anticipate the depreciating bias in INR to continue at a steady pace over the future.

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Topics: Rupee, Dollar, USD, INR, Exchangerate

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