Rupee can depreciate another 4% against the USD by 2019-end

The rupee appears to be moving down quite sharply since 31 July, which was when the US Federal Reserve announced a rate cut even though our forex reserves have been increasing ($430 billion for the week ended August 9, as against $411.9 billion at the start of the financial year).

The rate cut was an attempt to ensure that the strengthening US economy did not falter even as inflation remained low. Lowering of interest rates by the US Fed revealed a weaker economy, which should have made the dollar weaker; but that was not the case. In fact looking at the tendency for the yield curve to get inverted in the US, the market is looking at a possible recession which is foretold by such a development.

However, India was not the isolated case as there has been depreciation across most leading currencies in the world. The ongoing trade war of the US with China has also had its impact on the dollar as the odds are stacked in its favour.

Of the 17 currencies considered here (See chart), 16 declined against the dollar, while the Yen was the only one which appreciated during the period 30th July to 19th August. The appreciation in the Yen can be on account of the currency considered to be a safe haven asset, more than the US dollar.

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However, 12 of the 17 did better than the rupee with Brazil, Mexico and South Africa being the only countries to witness higher depreciation than the rupee. The rupee is down by 3.8 per cent during this period while the rand was down by almost 8.5 per cent.

Going ahead, depreciation of between 3-4 per cent for the year could be expected though global factors would continue to weigh heavily on the currency as well as FPI flows.

What else has been driving the rupee?

FPIs have turned negative and the budgetary announcement on tax surcharge has been a factor that has restricted their activity. Interestingly in August so far the investments in debt is still positive while being negative in equity at over $1 billion.

Uncertainty on the growth path of the Indian economy has also weakened sentiment that has affected the rupee. The Reserve Bank of India has revised its growth forecast for FY20 downward from 7 per cent in the June’19 meeting to 6.9 per cent in August’19 meeting. There are expectations that the government would announce some sector-specific measures which could help in stabilizing the rupee.

The future of exports this year also remains uncertain which has added to the sentiment. A weaker rupee could support exports at the margin.

The government was to raise sovereign bonds in the market this year. As there are indications that there could be a reconsideration of the same, the market has reacted as this means there would be fewer inflows of $10 billion.