Dollar has been rising upwards for most of 2019 and the simmering trade tensions will ensure that investor’s attraction towards safe haven assets which includes (dollar and gold) might further increase the strength in the reserve currency.
Rupee appreciated nearly 4 percent between October 2018 and December 2018. The turnaround was mainly on account of softening crude oil prices which led to domestic inflation cooling down during this phase. In this phase, Brent crude oil prices declined by nearly 35 percent and CPI inflation touched a low of 2.11 percent in December 2018.
The trend reversed in 2019 with rupee depreciating by nearly 3 percent from January 2019 to August 2019. Meanwhile, dollar index has continued to climb higher in the year and touched 98.25 in August 2019.
On account of CPI inflation remaining under RBI’s target of +/- 4 percent, RBI decided to cut interest rates three times by 25 bps in 2019 and one more time by 35 bps in August 2019 meeting taking the repo rate to 5.4 percent.
Interest rates are likely to follow a bearish path as the policy makers voiced concerns over a sharp slowdown in investment activity along with a continuing moderation in private consumption growth rate.
India economy slowdown – a drag
Meanwhile, the economy grew by 5.7 percent in the first quarter of 2019-20, the slowest pace in more than four years. Also, in latest report from Moody’s it decided to cut India’s GDP growth rate for 2019 to 6.2 percent amid economic slowdown. India Ratings too revised their GDP outlook downgrading it by 0.6 percentage points at 6.7 percent for FY20.
On the trade war front, Donald Trump increased tariffs from 10 percent to 25 percent on $200 billion of Chinese imports from June. Additionally, the US decided to increase tariffs to 10 percent on $300 billion worth of Chinese goods. US eventually delayed some of these tariffs sayings these tariffs would be implemented in two tranches, one on Septmber 1 and another on December 1 (2019), respectively.
In retaliation to these tariffs, China’s Ministry of Finance decided to levy tariffs between 5 and 10 percent on $75 billion of US imports. US retaliated again by increasing 5 percent tariffs over and above the additional initial tariffs on $550 billion of Chinese goods.
Easy Monetary Policy – The Agenda?
The US Fed had increased interest rates four times in 2018. In 2019 FOMC meeting it was highly unlikely for US Fed to increase interest rates, similar to 2018. In its last meeting in July 2019, Jerome Powell decided to cut interest rates by 25 bps amid slowdown in the economy. However, later during the meeting he mentioned the rate cut to be mid cycle adjustment trashing hopes of future rate cuts by the Fed.
Moreover, in the recent meeting of the Global Central Bankers at the Jackson Hole Symposium, Jerome Powell said that US Fed would provide further rate cuts if it’s needed by the economy keeping hopes of future rate cut alive.
In 2018, inflation was constantly above the 2 percent target set by US Fed and they were constantly adding up new jobs in the economy (190,000 jobs added in 2018 as compared to 180,000 in 2017). However, in 2019 inflation has remained subdued and below US Fed's target of 2 percent and US has added on an average of 156,000 jobs per month between January-July 2019 which is much lower than 2018’s average.
Trade banter – the recipe for depreciating rupee
Escalation of Sino-American trade war, continuous outflows from the Indian equity markets and weakening of Yuan against the dollar are possible combinations for a depreciating rupee in the near future.
The outflow of capital by the FII’s from the equity market stood at Rs 12,105 crore in August while the outflows from the capital markets (net of equity and Debt) stood at around Rs 2,940 crore, signalling the need of foreign investors bearish sentiments.
Although the trade and the tariff has been a consistent drag on the US as well as the Chinese economy, the US Fed’s efforts of reducing interest rates at a slower pace is not appreciated by US President Donald Trump. Donald Trump continued to criticize Jerome Powell over slow pace of rate cuts and liquidity to the system.
Dollar has been rising upwards for most of the 2019 and the simmering trade tensions will ensure that investor’s attraction towards safe haven assets (which includes dollar and gold) might further increase the strength in the reserve currency. Hence, the likely trend of rupee is to move higher (CMP: 72) towards the 74 mark by the end of September 19.
(The author is Research Associate - Currencies at Angel Broking.)Disclaimer: The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.Get access to India's fastest growing financial subscriptions service Moneycontrol Pro for as little as Rs 599 for first year. Use the code "GETPRO". Moneycontrol Pro offers you all the information you need for wealth creation including actionable investment ideas, independent research and insights & analysis For more information, check out the Moneycontrol website or mobile app.