Rupee seen trading close to 85.80 per dollar by March end: BS Poll

Excessive intervention by the RBI could be counterproductive, particularly if other central banks allow their currencies to weaken, and could even affect rupee liquidity

After experiencing 2.19 per cent depreciation against the US dollar in the current financial year (FY25) so far, the rupee is expected to weaken further as the American currency is expected to strengthen given the US Federal Reserve's indication of fewer rate cuts in 2025.  According to the median of a Business Standard poll, the rupee is seen trading at Rs 85.78 per dollar by the end of fiscal year 2025, or March 2025. Emkay Global Research has gone further, estimating the Indian unit will fall to Rs 86.25 per dollar in this timeframe.  The rupee has depreciated by 0.91 per cent in December so far. In the current calendar year, it has depreciated by 2.42 per cent.    Major central banks such as the European Central Bank (ECB), Bank of England (BoE), and People’s Bank of China (PBoC) are likely to adopt more dovish stances, as their economies face significant growth challenges. This divergence in monetary policy between the Fed and other central banks is expected to sustain the dollar's appreciation trajectory, said respondents.  The dollar index rose to 108.15 on Thursday. It measures the strength of the greenback against a basket of six major currencies. Consequently, the rupee settled at a new low for the third consecutive trade at Rs 85.27 per dollar on Thursday.  Respondents said that an excessively interventionist approach by the Reserve Bank of India (RBI) could be counterproductive, particularly if other central banks allow their currencies to weaken in response to external pressures, such as possible US-imposed tariffs under President-elect Donald Trump, who will assume office on January 20, 2025.  “The dollar is expected to strengthen, now that the Fed has signaled fewer cuts in 2025. The RBI seems to be more willing now to let the rupee adjust as it would help support growth. Q2 GDP numbers were extremely disappointing. For revival of growth, export and manufacturing need to do well and for that to happen, it is imperative that the rupee remains competitive relative to other Asian peers, especially Chinese yuan,” said Abhishek Goenka, chief executive officer at IFA Global.  “The heavy-handed approach to intervention can prove to be counterproductive if other central banks let their currencies weaken in response to imposition of tariffs by the US on imports under the Trump regime. It will result in rupee overvaluation and tightening of domestic monetary conditions, jeopardising growth in the process,” he added.  The US rate setting panel has projected a 50 basis point rate cut in 2025, followed by another in 2026. With a 100 basis point cut in 2024, the Fed is likely to pause rate adjustment until mid-2026, with future decisions contingent on conditions after Trump takes office. One basis point is a hundredth of a percentage point.  Along with the strengthening dollar, the sharp deterioration in India’s balance of payments (BoP) during the third quarter of the current financial year further weighed on the rupee. Data on foreign exchange reserves indicates that the BoP for FYTD25 (up to December 20) is tracking a significant deficit of approximately $25 billion. This reflects a widening trade deficit alongside a marked slowdown in capital inflows, both in terms of Foreign Portfolio Investments (FPI) and Foreign Direct Investments (FDI).  “The depreciation pressure on the INR reflects dollar strength and India’s balance of payments turning deep negative in Q3FY25," said Gaura Sen Gupta, chief economist at IDFC FIRST Bank.  In response, the RBI has intervened to moderate the pace of the rupee's depreciation. However, this strategy has led to unintended consequences. First, the rupee’s relative valuation has increased as other currencies have experienced sharper depreciations against the strengthening US dollar. As of November 2024, the rupee is overvalued by 8.1 per cent on the Real Effective Exchange Rate (REER) metric, highlighting the currency’s misalignment with underlying fundamentals.  Second, the RBI’s interventions have resulted in a significant depletion of rupee liquidity in the domestic market. This tightening of liquidity has pushed overnight rates closer to the Marginal Standing Facility (MSF) rate, indicating stress in short-term funding conditions.  Respondents to the Business Standard poll said that allowing the rupee to adjust at a faster pace would help alleviate the overvaluation pressure, realign the REER closer to its equilibrium level, and reduce the strain on both forex reserves and domestic interbank liquidity.  RBI intervention has focused on moderating the pace of depreciation, however it resulted in rising overvaluation of the rupee as other currencies have depreciated against the dollar more sharply. On the REER metric INR overvaluation is tracking at 8.1 per cent as of November 2024, Sen Gupta said, adding that another impact has been a significant drain on rupee liquidity which has resulted in overnight rates moving closer to MSF. Looking ahead, allowing the INR to depreciate against the USD at a faster pace will reduce the overvaluation as well as the drain on FX reserves and domestic interbank liquidity.