Asian Currency

Record low INR: Stability or imminent depreciation?


Recent market volatility has been spurred by a confluence of factors. Weaker-than-anticipated US economic data has ignited concerns about a potential recession, with market estimates now placing its likelihood at 30-35%, a significant increase from the less than 10% projection in June 2024. Adding to the turbulence, the surprise rate hike by the Bank of Japan and the subsequent reversal of yen carry trades have exacerbated market uncertainty. The Indian Rupee has borne the brunt of this volatility, hitting near all-time lows and breaching its previous October 2022 record of INR 83.5. While the Rupee has depreciated in the short term, it has exhibited relative stability compared to other emerging and developed market currencies over the past six months.

chartETMarkets.com

INR performance V/s Emerging Market Currencies (YTD INR depreciation ~1% v/s other EM currencies ~4-10% depreciation)The big picture question is should RBI be worried about INR and is there any significant depreciation expected in near term horizon?

In light of recent depreciation of the Japanese Yen, Chinese Yuan, Indonesia rupiah and other emerging and developed market currencies, coupled with the looming fears of geopolitical tensions, trade wars and tariffs, there is widespread concern about the possibility of near-term INR depreciation and its implications on monetary policy. However, we believe that the INR will continue to remain stable with no major risk of volatility or depreciation in the current fiscal year.

This is largely on account of:


Strong Macro Health
: India’s economy has demonstrated remarkable resilience, particularly in the face of global economic challenges. Key indicators such as Gross Domestic Product (GDP), inflation, and fiscal and current account deficits (twin deficits) have undergone a substantial transformation over the years. These improvements are the result of a combination of factors, including structural reforms, policy initiatives, and a growing emphasis on economic development. While challenges persist, the Indian economy’s resilience has positioned it as a bright spot in the global economic landscape.

Strong FPI Flows and Growth in Services: India has witnessed robust Foreign Portfolio Investment (FPI) inflows and a burgeoning services sector this year, amounting to approximately USD 15 billion in debt and equity investments. This positive trend is attributed to the stable economic policies and continuity of governance following the re-election of the incumbent government. The Balance of Payments (BOP) is projected to maintain a surplus due to several factors. The inclusion of Indian bonds in the JP Morgan Indices is anticipated to attract around USD 20 billion in inflows. Additionally, India’s growing share in global trade, primarily driven by the expansion of service exports, is bolstering the BOP. Furthermore, the emergence of India as a global capability center, with over 1600 multinational corporations establishing their global capability centers (GCCs) in the country, is contributing significantly to the positive economic outlook.

Weak US Macros Build Case for Dollar Depreciation: High fiscal deficits, rising debt to GDP and weak US macro data would lead to weak dollar, which should offset any major depreciation and lead to relative INR strength. The last quarter has seen an overall slowdown in all major US macroeconomic indicators like employment, CPI, retail sales. Though indicators have softened significantly, one does not expect the US to enter into a recession in the near term.

Strong Reserves Build Up: India has built up huge reserves to the tune of ~675 bn USD which acts as a cushion to avoid near term volatility and can be used to defend INR against any big shocks.

Slowdown in China: There was high expectation of market from Chinese Communist Party’s Third Plenum communiqué for driving the consumption growth, but lack of any big bang measures has led to continued weakness on growth prospects for the economy in near term.

Impact of the same has led to weaker commodity prices especially Oil, which in turn is beneficial for our currency as it leads to lower import bill.

Impact of Currency on Bond Markets and RBI Monetary Policy

Currency depreciation often triggers a hawkish response from central banks. This is primarily due to their dual mandate of maintaining financial stability and controlling inflation. A weakening currency can fuel inflationary pressures, prompting central banks to adopt a more restrictive monetary policy stance. Such actions typically dampen bond prices, leading to higher yields. By keeping liquidity and financial conditions tight, the RBI aims to curb inflationary expectations and safeguard currency stability. This stance could temporarily hinder the bond market rally and introduce some volatility.

To defend the INR against potential depreciation, the RBI has been actively utilizing its substantial foreign exchange reserves. However, these interventions can drain banking system liquidity, exerting upward pressure on short-term interest rates. Recent data indicates that the RBI has already intervened to the tune of approximately USD 10-15 billion in the past few trading sessions. To offset the liquidity injected through the inclusion of Indian bonds in the JP Morgan Indices, the RBI is expected to conduct Open Market Operations (OMOs) to absorb excess liquidity. While this measure is likely to be modest, it could temporarily dampen the enthusiasm in the bond market. Despite this, the overall positive demand-supply dynamics for bonds are expected to prevent a significant yield surge.

In the event of a severe INR depreciation triggered by global risk-off sentiment or geopolitical tensions, the RBI is likely to maintain a prolonged pause in its rate hike cycle. This stance would deviate from market expectations and could further impact bond yields.

(The author Devang Shah is Head Fixed Income, Axis Mutual Fund. Views are own)



Source link

Leave a Response