Rupee may fall to 82 to a dollar this year but RBI unlikely to defend aggressively, say currency experts

The rupee has depreciated 1.8 percent this month, so far, and lost 2.4 percent in July-September, data showed. The rupee is down 8.1 percent since January but has fared better than some of its EM peers like the Chinese yuan and the Korean won, which have dropped by 10.43 percent and 15.63 percent, respectively, against the dollar in the same period, according to Bloomberg data.

“A hawkish Fed and recessionary conditions in Europe and China are going to hurt EM currencies. Therefore, till December we could see the rupee trade at 82 levels,” said Anindya Banerjee, vice president - currency derivatives & interest rate derivatives at Kotak Securities.

Europe and China, Banerjee said, are the two of the three largest economic blocks that are facing recessionary conditions. EM economies, including India, have a deep interlink on the trade front with them, he added. A major economic slowdown can not only hurt growth but also impact portfolio flows into India, warned Banerjee.

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Why is the rupee falling?

The rupee has been under pressure since the Russia-Ukraine war began in late February. The war accentuated concerns of inflation across economies amid supply-side constraints. Central banks have begun to hike interest rates aggressively to quell inflationary pressures. This, analysts say, could slow down global growth and spark a recession.

US inflation, for example, rose to 8.3 percent in August, significantly higher than the Fed’s 2 percent target range. The Fed raised interest rates by 75 basis points (bps) to 3-3.25 percent on September 21 and signalled cumulative rate hikes worth 125 bps in 2022 alone. The Fed has raised rates by 300 bps so far in 2022. One bps equals one-hundredth of a percentage point.

The Bank of England has also hiked its base rate by 50 bps to a 14-year high of 2.25 percent. This was the seventh consecutive hike by the central bank, which stated that the UK is already in a recession.

Tighter policy rates and fears of recession have led to a stronger dollar as investors shun risk assets for safe-haven investments. Foreign investors have already pulled out $20.19 billion from India’s debt and equity market so far in 2022, according to data by National Securities Depositories Ltd.

“Widening interest rate differentials and withdrawal of global liquidity, along with persistently elevated inflation, are expected to weigh across risk assets,” said Upasna Bhardwaj, chief economist at Kotak Mahindra Bank. “Against this backdrop of strong US dollar, aided by Fed upping its stance against inflation and weaker Chinese yuan, the EM currencies are likely to remain under pressure.”

Bhardwaj said there is “visible room for rupee depreciation” going forward. She expects the rupee to trade within 79 to 83 per dollar for the rest of FY23.

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Odds stacked up against the rupee

“Apart from the stronger dollar, the mismatch between dollar demand supply and the widening twin deficit will be the biggest hurdle for rupee strength,” said Dilip Parmar, a research analyst at HDFC Securities. “So, far RBI has managed to neutralise the flows and rupee but if the global economy sinks we will definitely feel the heat which could be rupee negative.”

He expects the rupee to trade in a range of 79 to 82 per dollar in October-December.

According to Anil Bhansali, head of treasury at Finrex Treasury advisors, a higher trade deficit in India would result in a wider current account deficit going forward. This is the key risk to the rupee as imports would be costlier leaving India vulnerable to imported inflation, he said.

India’s merchandise trade deficit in August more than doubled to $28.68 billion from the same period year ago, driven by a sharp jump in imports while exports shrunk. The deficit stood at $11.71 billion in August 2021.

RBI intervention to be less aggressive

Another reason why the rupee could be under pressure is the likelihood of a less-aggressive intervention by the RBI, said analysts. This could be to allow the rupee to play catch up with other EM peers and protect the fast-depleting foreign exchange reserves, said experts.

The RBI is responsible for maintaining the rupee’s stability. Whenever the rupee has depreciated significantly, the RBI has stepped into the market by selling dollars from its forex kitty. The central bank sold net $19.05 billion in the spot market in July, RBI data shows. India’s foreign exchange reserves have fallen to $550.87 billion as of September 9 from an all-time high of $642.4 billion last year.

“Considering that forex reserves are down to around $550 billion, India’s import cover is currently for about 10 months. Thus, RBI intervention possibly may not turn out to be aggressive, though their interim presence may be felt in the market,” said Kunal Sodhani, vice president, global trading center at Shinhan Bank.

If the dollar is gaining strength globally, the rupee cannot be kept artificially higher and may have to align itself accordingly, added Sodhani.

Arnob Biswas, head of forex research at SMC Global Securities concurred.

“We don't think RBI will offload dollars aggressively to defend the rupee like other Asian central bankers are doing – either with large rate hikes or massive dollar spot selling,” said Biswas.

Most economists do not expect the RBI to be bothered by the narrowing interest rate differential between the India and US at this month’s monetary policy meeting on September 30 and follow the Fed’s aggressive rate hike path. The RBI is expected to hike rates by 35 to 50 bps this month.

CR Forex’s managing director Amit Pabari said the RBI will raise rates by “at least” 30 bps this month.

“Looking at the current fundamentals and global scenario, we expect it to depreciate further towards 81.50 in the near term, and by December 82-82.50 levels can be expected,” he added.