US inflation, rising crude weigh on rupee


No volatility is expected, thanks to strong external fundamentals of the Indian economy



NOVEMBER 12, 2021 / 10:53 AM IST

Unlike in 2013, there was no tantrum in emerging market currencies after the US Federal Reserve announced it was tapering asset purchases. However, as US inflation touches a 30-year high, investors are starting to bet that the Fed Open Markets Committee will advance rate hikes, which will put pressure on EM currencies like the rupee.

On Thursday, the rupee closed at 74.51 to a dollar, down 14 paise from the previous close. As US consumer price inflation rose to 6.2 percent from a year ago, US treasury yields increased and the dollar index shot up to a 16-month high.

In the near to medium term, rupee is likely to further weaken against the dollar because of all too familiar factors.

One, oil prices are rising. Brent crude is trading close to $85 a barrel. The prices of other commodities too remain elevated. That means India’s current account surplus is likely to turn into a deficit all too soon driven by demand for imports and rising prices. According to Gaurav Kapur, Chief Economist of IndusInd Bank, for the full financial year 2021-22, current account deficit could rise to one percent of GDP.

Two, higher US bond yields and quicker than expected rate hikes are a dampener for foreign investment inflows into emerging markets equities and bonds.

Already, foreign investors appear to be switching off because of expensively prices Indian equities. After investing around Rs 15000 crore in local stocks in August and September, foreign investors have pulled out Rs 19000 crore since the beginning of October. Downgrades by the likes of Morgan Stanley and Nomura added to their pessimism and it was left to local investors to drive the markets ahead.

Then, there is the Evergrande crisis playing out in China which is headed for the slowdown. The property developer huffed and puffed to stave off a default on Wednesday, but if it actually defaults, then it could spark a flight to safety among investors.

That said, it is not all bad news. India is in a far better position today than in 2013 when the start of the taper sent the rupee into a tailspin.

Even if oil rises further, economists say that the current account deficit won’t top 2 percent of GDP because of strong exports. In 2013-14, it was around 4.8 percent of GDP.

Moreover, India has built up enough foreign exchange reserves over the past couple of years taking advantage of robust inflows. These reserves are enough to cover at least 13 months of exports and 113 percent of India’s foreign debt.

Overall, the macroeconomic stability that India represents and rising growth now will ensure that foreign inflows will be sufficient to more than cover the deficit. Events such as India’s inclusion in global bond indices will only help.

Second, as Madhavi Arora, economist at Emkay Global, points out: The “market [is] pricing in more hikes into 2022 and 2023 at the expense of decreasing hikes in 2024 – remarkably, keeping the terminal rate unchanged at around 6 hikes.”

Moreover, “historically, Fed has never begun a hiking cycle with real interest rates at such a low level, much less at a negative level.” The current real interest rate for 10-year paper is -1.2 percent in the US.

Thus, while the rupee may have a depreciation bias in the near term, a stable economy and rising growth trajectory will mean that any downward movement will not be volatile.

FIRST PUBLISHED: NOV 12, 2021 08:45 AM

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