- September 26, 2022
- Posted by: Amit Pabari
- Category: Uncategorized
The rupee breached the 81 mark against the US dollar for the first time ever, following a fresh 20-year high in the dollar index after the Fed announced a 75-basis-point hike in the key US interest rate. Equities across the globe fell sharply and US bond yields hit multi-year highs.
What does the road ahead look like for the rupee?
Here’s a look at the key factors impacting the rupee at the current juncture:
Stronger USD: After worsen than expected US CPI data, multiple US yields spiked to their highest levels since 2007-2008, boosting the appeal of the greenback. The rally in the dollar index — which gauges the American currency against six peers excluding the rupee — continued towards 111.5.
The revised dot plots suggest a further one percent hike for the year, which would take the terminal rate above four percent. One can expect the dollar index to head higher towards 112.5-115 levels over the medium term, and the euro and the pound to fall towards 0.95 and 1.08 levels respectively.
Weaker emerging market currencies: Emerging market countries are vulnerable to the stronger dollar. However, the rupee is down 8.4 percent so far this year but manages to fare better than emerging market currencies. The rupee’s immediate peer — the yuan — is down more than 11 percent on a year-to-date basis.
Fears of a recession: Almost 89 percent of countries are experiencing inflation above six percent, including many developed nations. Almost all major central bankers have hiked their interest rates though at the cost of growth, unfortunately.
Currently, 80 percent of major economies are seeing a slowdown in real gross domestic product (GDP) growth.
The chances of a recession in Europe and the UK over the next year have increased significantly, which could lead to a spiraling effect across the financial market.
Widening trade deficit: India’s major concern is its trade deficit, which has widened to a record $28 billion in a month — almost double the usual $13-15 billion. However, some inflows in the past two months have taken away some of that pressure.
Once foreign portfolio investors (FPIs) turn bearish and start to withdraw the funds on rising US rates, the rupee could come under pressure.
India’s bond inclusion: There has been a buzz in the bond market that India may finally be included in the JP Morgan Global Bonds Index-Emerging Markets, opening the door to a flood of foreign capital.
Any development could aid appreciation in the rupee to 79.50-79 levels.
Domestic equity outperformance: When most of the world markets are down by more than 10 percent, Indian equities are showing resilience boosted by FPI inflows.
Consolidation in the past two months was surely a lull before the storm. The RBI fairly controlled the currency to keep the foreign investor’s interest intact ahead of bond inclusion talks. However, the Fed’s hawkish policy, including the 75-bp hike, led to a fall in rupee to record lows.
The RBI may not be able to use forex reserves aggressively, with the banking system liquidity falling to a 40-month low. It might have to let the rupee fall to its fair value, in line with emerging as well as developed market currencies. With a stronger dollar, sliding EM currencies and a gloomy global situation, the rupee may not be an outlier anymore.
There is an almost 75 percent chance of the rupee depreciating towards 81-81.50 levels. The only thing that could make the USD-INR pair return to levels below 80 is news of India’s inclusion in the bond index, which could take it to the 79.5-79 band. But the chances of that happening appears to be grim.
–Amit Pabari is Managing Director at CR Forex Advisors. The views expressed in this article are his own.