Indian Rupee (INR) - August 2016

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Following the UK’s shock Brexit vote we now do not expect the Federal Reserve to hike interest rates until December, while almost every other G10 central banks remain overwhelmingly in easing mode. However, after the strength seen in the last two US labour market reports, we think that the risk to our Fed hiking forecasts are to the upside and it's now far more likely that we’ll see two hikes in 2016 than none at all.

By contrast, the Bank of England cut interest rates for the first time in nine years in August, with the European Central Bank looking likely to expand its quantitative easing measures later in 2016. Further, the Bank of Japan announced a modest expansion of its monetary stimulus program, while the Japanese Government will significantly expand stimulus spending.

We think that the backdrop of extraordinarily stimulative policy from the main central banks, with the notable exception of the Federal Reserve, and a clear shift towards more accommodative policies in the laggard economies (e.g. Japan) is generally positive for risk assets and emerging market currencies in particular.

The Indian Rupee (INR) has held up relatively well in the context of most emerging market currencies, suffering only a very mild and gradual depreciation against the US Dollar since mid-2014 (Figure 1).
The currency has been well supported by India’s relatively strong economic performance, which has seen India become the fastest growing major economy in the world.

 

Figure 1: Historical Evolution of USD/INR (2011 – 2016)

Source: Thomson Reuters Datastream Date: 08/08/2016

 

INTEREST RATE CUTS

This relative INR strength has come despite a series of interest rate cuts over the past year, which were intended to boost inflation in India. After the latest cut in April, the Reserve Bank of India has brought its benchmark interest rate all the way down to 6.5%.

Persistently low inflation, and government plans to lower the budget deficit to 3.5% of GDP this year, is expected to force the RBI to cut rates further in the coming months. Consumer price growth has remained low and has been below the bank’s upper target of 6% for about a year and a half, registering 5.8% in June (Figure 2).

 

Figure 2: India Inflation Rate (2012 – 2016)

Source: Thomson Reuters Datastream Date: 08/08/2016

 

The recent rate cuts, coupled with poor harvests and a moderate recovery in oil prices, appear to have stabilised inflation around its highest level in over a year. Real interest rates in India, however, remain positive and have increased to around 1.5%, which should continue to provide some support for the Rupee.

STRONG ECONOMIC GROWTH

Economic growth in India has also continued to be strong, with the recent oil price slump positive for the predominantly oil importing Indian economy. GDP growth dipped to 7.3% in the fourth quarter, although India remains the fastest growing major economy in the world having outpaced China last year. Growth is expected to remain robust in 2016 and well above 7%.

The current account deficit has seen a massive improvement in the past few years and is now largely closed. With oil imports now double oil exports, the recent plunge in oil prices has been a sizable net positive for the balance of trade, which has experienced one of the sharpest improvements of any major emerging market economy over the past three years (Figure 3).

 

Figure 3: India Current Account (2000 – 2016)

Source: Thomson Reuters Datastream Date: 06/07/2016


FOREIGN EXCHANGE RESERVES

The Reserve Bank of India has also actively intervened in the foreign exchange market, selling its US Dollar reserves in the past few months in order to limit volatility and prevent an excessive Rupee depreciation.

However, India’s foreign exchange reserves remain lofty, reaching an all-time high level in March. They are now ample at above the equivalent to thirteen months’ worth of import cover (Figure 4).

 

Figure 4: India Foreign Exchange Reserves (2011 – 2016)

Source: Thomson Reuters Datastream Date: 06/07/2016

 

Governor of the Reserve Bank of India Raghuram Rajan has suggested that the central bank will not hesitate to use its FX reserves, to keep the currency well supported in the coming months.

WHAT DOES THE FUTURE HOLD FOR INR?

The stream of supportive factors, including rapid growth, an improving current account and intervention from the central bank leads us to expect a mostly stable Rupee against the US Dollar during the remainder of this year and throughout 2017.

This, in our view, would ensure a gradual appreciation of the currency against the Euro, given the large scale easing measures announced by the European Central Bank. The Rupee should also experience a moderate depreciation against Sterling.

 

 

USD/INR

EUR/INR

GBP/INR

Q3-2016

67

70

87

E-2016

67

65

87

Q1-2017

67

64

87

Q2-2017

67

64

87

E-2017

67

64

87

 

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