By Mihika Sharma
The Indian rupee has slightly weakened by 0.3% against the dollar in August, reaching a new record low of 83.98 on August 12. This contrasts with most other Asian currencies which have strengthened against the dollar during the same period. Notably, the Malaysian ringgit has appreciated by 3%, the Indonesian rupiah by 1.9%, the Japanese yen by 1.9%, and the Chinese yuan by 0.6% in the month so far.
The rupee’s decline can be largely attributed to the unwinding of global carry trades. In these trades, investors use low yielding currencies such as the Japanese yen and the Chinese yuan to fund long positions in the rupee.
However, investors started exiting carry trades after the Bank of Japan (BoJ) delivered a hawkish policy in July, raising its policy rate more than expected. Additionally, a fall in the dollar index, driven by weak US job market data, also contributed to the unwinding of carry trades.
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The US unemployment rate unexpectedly increased to a three year high of 4.3% in July from 4.1% in June, raising recession concerns and prompting markets to price in more aggressive Fed rate cuts. Consequently, the odds of a 50bps rate cut by the Fed in September surged to 100%, with markets now pricing in a total of 100bps of Fed rate cuts in 2024, up from the previously expected 50bps.
Despite this, interventions by the Reserve Bank of India (RBI) limited rupee’s fall and kept volatility in check. Additionally, the RBI’s decision to leave the policy rate elevated also limited rupee’s depreciation.
Looking ahead, the unwinding of carry trades is expected to slow, particularly with dovish signals from the BoJ. BoJ Deputy Governor Uchida has emphasized the importance of keeping Japan’s monetary policy easy for the time being. This has led to a partial reversal of gains for USD/JPY, which has moved to around 147 from 144 a week earlier.
Easing US recession concerns should also reduce pressure off the rupee. Recent data suggests that markets may have overreacted to the higher US unemployment rate.
The ISM PMI services index for July indicates increased hiring activity, and the initial jobless claims remains below pre-pandemic levels, suggesting the labour market may not be cooling as quickly as previously thought. Consequently, markets have re-assessed their bets of Fed rate cuts and the odds of a 50bps Fed rate cut in September have moderated to 52%, down from the earlier 100%.
In the coming week, US consumer price index (CPI) data will be closely watched. With inflation expected to move closer towards the Fed’s 2% target, this should keep market expectations of Fed rate cuts in place, particularly given recent comments from US Fed officials suggesting a rate cut as early as September, and may provide some support to the rupee.
However, rising oil prices remain a key monitorable. Brent crude oil prices, which had moderated to around USD 76 per barrel last week, have rebounded to around USD 81 per barrel due to escalating tensions in the Middle East, which threaten to disrupt supplies. Still, demand concerns in China are likely to limit the upside in oil prices.
The ongoing volatility in global markets has also led to foreign portfolio outflows and is putting pressure on the rupee. FPIs have pulled out USD 1.7 billion from Indian stocks in August (as on August 12). Nevertheless, the debt segment has experienced net FPI inflows of around USD 852 million over the same period, supported by India’s bond index inclusion.
We expect the rupee to trade between 83.60 and 84.10 in the near term. It may find support from a slowdown in unwinding of carry trades and easing US recession concerns, though rising oil prices could pose a challenge.
(About The Author: Mihika Sharma, Associate Economist at CareEdge Ratings)
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