Is the end of Rupee’s woes in sight?

Against the backdrop of turmoil in China and jitters over a looming US interest rate hike, the Indian rupee has been gripped by Bears in recent times as an uncertain global economic outlook triggered a capital flight from emerging markets. The Rupee has shed 4% of its value this year, while tanking over 2% since August 11 when China’s decision to devalue the yuan by the most in two decades sent shock waves to financial markets worldwide. However, the US Federal Reserve’s surprise decision to refrain from a hike in borrowing costs brought some relief to the domestic currency, which registered its biggest gain vs the greenback in two years, surging to a one-month high on Friday.

However, the rupee’s comeback may be short-lived with high uncertainty still prevailing on the global front, meaning that the currency will be prone to downward pressure that will be cushioned by expectation of further policy easing by the RBI and hopes of progress on key reforms. We explain below why.

Firstly, Even as it maintained status quo on interest rates last week, Fed meeting materials show that 13 out of the 17 policymakers warrant a rate hike this year, meaning that markets must brace for US policy tightening in the near-term. The Fed which has kept its key rate near Zero since 2008, next meets on October 27-28 and then on December 15-16. Higher interest rates in the US will increase the lure for US dollar denominated assets that may lead to further capital outflows from risky assets, causing the rupee to depreciate, taking severe toll on Indian companies having large overseas debt.  Foreign investors, who pulled out a record Rs 17,428 crore from Indian stocks in August 2015, have emerged as net sellers of Indian equities & bonds to the tune of Rs 4,600 crore in September, thus far.

Secondly, the ‘China’ factor will continue to dominate sentiment across global markets with uncertainty surrounding the full extent of the country’s slowdown. Recent factory, investment and export data have signaled that China’s woes seem to be deepening, defying efforts by policymakers to fix the country’s slowdown. Being the world’s second biggest economy and the largest commodity player in the world, a rout in China means diminished fortunes for the global economy, hence inviting risk aversion among foreign investors.

Thirdly, it is foolish to pin the entire blame of an FII exodus on global factors as slow progress on key reforms such as the GST which has been derailed by political headwinds, and a domestic economic slowdown have also contributed to the rupee’s slide in recent weeks. India’s economic growth slowed to 7% in the June quarter from 7.5% in Q4 FY 2014-15 while exports have been in contraction terrain for nine straight months.

However, its’ not entirely looking murky for the rupee as the Fed’s move to hold off an interest rate hike has almost guaranteed an RBI rate cut on September 29 which should support sentiment. The possibility of at least another rate cut beyond September, in the ongoing fiscal, looks high as a softening global commodity cycle amidst weakness in China keeps oil prices lower, narrowing the fiscal and current account deficits, taming inflation. At the same time, the RBI will keep a close watch on the effect of a deficient monsoon on food prices which may limit policy easing room.

On the growth front, much rests on the Modi government’s ability to fast track key reforms with hopes riding high on the passage of the GST bill in the Winter Session of the Parliament. Recent measures to boost public investment in roads and railways may bolster economic growth while a quick fix on the problems plaguing the banking sector which is sitting on a pile of stressed assets, is also the need of the hour, a move which may revive credit growth and accelerate the corporate investment cycle.

The Bottom-line- the Rupee may continue to depreciate against its US counterpart in the coming months amidst uncertainty over China and a US rate hike,  with hopes of a rebound in the domestic economy  likely to offer some relief.