The good, the bad and the ugly: Where will the rupee end up?

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The Indian rupee has plummeted to fresh all-time lows over the last several days as emerging market assets are battered by a global risk-off, which has triggered a flight to safe-haven assets. Meanwhile, foreign money continues to leave Indian assets even as the trade deficit worsens.

Yet, the rupee has performed better, compared with several of its Asian peers and the Reserve Bank of India (RBI) is committed and well prepared to contain the volatility in the exchange rate.

India is also no longer a part of the so-called ‘fragile five’ economies that had seen hefty capital outflows and currency meltdowns in 2013.

Going ahead, the key variables that would decide the trajectory of the rupee’s exchange rate are the Russia-Ukraine war, crude oil and commodity prices, the depth of the European slowdown and US recession, and how central banks react.

So what are the likely paths for the currency from here?

The good

This is a less likely scenario and one that most forex analysts expect won’t play out anytime soon.

But if it does, the most the rupee could appreciate to is the level of 76.00 to 76.50 to the dollar, analysts said.

For this to happen, crude oil prices will need to continue to cool down and stay below the recent peaks, the US recession would need to be shallow and short, and the Russia-Ukraine war must not escalate further, thus preventing a further spike in food and commodity prices. That may be wishing for a lot.

Still, if these conditions were to unfold, the RBI would not allow the rupee to appreciate much against the greenback.

“The modus operandi of the RBI is pretty clear,” Anindya Banerjee, vice-president, currency and interest rate derivatives at Kotak Securities, said. “When it is a weak dollar, the rupee will appreciate much less than other currencies.”

As soon as the rupee gets to a level of 77.50 or 78.00 to the dollar, the central bank will start buying dollars, said Abhishek Goenka, CEO and Founder at IFA Global.

The bad

This is the base case, with the rupee likely to depreciate gradually, going forward, guided by the RBI’s gentle hand. Policymakers prefer such an approach as it will correct the rupee’s overvaluation and ensure that Indian exporters and importers are protected.

The rupee-dollar pair has been one of the least volatile dollar pairs in the recent past, a testimony to the central bank’s deft management of the foreign exchange market.

“The trajectory of the rupee right now is definitely weak,” said IFA Global’s Goenka. “I am not very bearish on the rupee. I do expect that possibly we could see 80-plus but that is not something that cannot be controlled.”

The central bank is expected to support the currency with not only dollar sales in the spot, forwards and other derivatives markets but also by hiking policy rates further, which will make debt assets more attractive for foreign investors.

Also read: Rupee exchange rate under close watch of RBI and government, says finance minister

Note that, currently, the rupee is overvalued by around 4-5 percent on a real effective exchange rate basis.

The ugly

The following are the possible scenarios which could play out following a sharp depreciation in emerging market currencies amid huge outflows, if the US recession turns out to be much worse than expected.

The rupee could hit 83.00-83.50 to the dollar although weak risk sentiment could push the currency further lower.

To be sure, the RBI, which has been walking the talk with its hefty dollar sales, will curb the fall in the rupee, if the worst is to happen.

The central bank is estimated to have sold $30 billion-$40 billion in the spot and forwards markets over the past six weeks. Even if foreign outflows were to accelerate, the RBI is capable of offsetting those as it seeks to maintain the rupee’s performance among the EM pack.

“RBI has ample reserves, so even if they intervene another $50 billion - $60 billion, they can comfortably absorb it,” Kotak Securities’ Banerjee said. “They have enough. For the Indian rupee to become an outlier, I think it looks unlikely.”

Finally, the bottom-line across the three scenarios is that the market and the central bank are in sync and there is no panic like we saw during the taper tantrum in 2013.