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Indian Rupee Underperforms Emerging World Rivals after RBI Signals Pause in Hiking Cylce

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- INR underperforms Wednesday after RBI hits pause. 

- RBI cuts inflation forecasts and signals no further hikes.

- But risks still exist, stance remains "calibrated tightening". 

The Rupee underperformed emerging world rivals Wednesday after the Reserve Bank of India (RBI) hinted that it could take an extended break before raising interest rates again. 

India's central bank left its interest rate unchanged at 6.5% on Wednesday but continued to describe its policy stance as one of "calibrated tightening". 

However, the bank cut its forecasts for inflation in 2019 and 2020 so that the consumer price index is now seen close to the 4% target over coming years. 

Indian inflation has remained below the 4% target for three consecutive months now,and fell to 3.3% in October. RBI officials project it will fall as low as 2.7% before rising back to 3.2% in the first-half of 2019. 

"The decision appears to have been driven in part by the recent weakness of headline inflation as well as the sharp fall in global oil prices in the last few weeks," says Shilan Shah, an economist at Capital Economics.

Lower forecasts and division on the rate setting committee point to lesser odds of another rate rise coming any time soon. One RBI rate setter already voted to reverse the recent change in 'stance' from 'neutral' to 'calibrated tightening'

Radhika Rao, an economist at DBS Bank, says the risk of another rise in inflation further down the line likely explains why other rate setters decided to keep the RBI's stance set to 'calibrated tightening'. 

"The central bank’s commentary on still-high core inflation, a closed output gap and external uncertainties (INR, oil, global growth etc.) suggest that a dovish turn is not imminent," Rao adds, in a note to clients Wednesday. 

The USD/INR rate was quoted at 70.52 Wednesday, unchanged for the session, but has risen by 10.5% in 2018. It had risen as much as 16% during the 10 months to the beginning of November.

The Pound-to-Rupee rate was 0.20% higher at 89.83 and has gained 4.5% this year. It had risen almost 10% going into November.

That performance came on a day when almost all other emerging market currencies were able to win back ground previously ceded to the U.S. Dollar. 

India's currency, economy and central bank had been under increasing pressure from a multitude of factors that have stoked inflation and threatened the outlook for price stability in 2018. 

The currency originally suffered in response to Federal Reserve (Fed) interest rate, which has sucked capital out of and deterred flows away from the emerging world this year. 

Downward momentun in Rupee exchange rates built further during the summer as global oil prices climbed, and reached a crescendo in October when 2018 gains for Brent crude approached 20%. 

Those pressures saw the RBI raise its interest rate by 25 basis points twice, leaving it at 6.5%, in order to tame inflation and stabilise the currency.

However, since then, the oil market has gone from boom-to-bust and investors are now openly speculating that the Fed could soon press the pause button on its own rate hiking cycle

"Despite expecting Emerging Market Asia to underperform the overall EM complex, we highlight select local stories we expect to generate alpha against regional peers," says Hans Redeker, head of FX strategy at Morgan Stanley. "We think that India offers the best growth potential and we expect USD/INR to reach 68 (down ~4% from current levels) by end-2019."

Redeker says buying the Rupee is one of their top trade ideas for the 2019 year ahead. They anticipate that India will benefit from the ongoing rout in oil markets, which will reduce concerns about the current account deficit.

Morgan Stanley also says India's economy will grow faster than that of any other major country, enabling the Reserve Bank of India to raise interest rates at roughly the same pace as the Federal Reserve, which could neutralise the impact that U.S. interest rate policy has on the Rupee going forward.

"The RBI is the only Asian central bank our economists expect to hike in tandem with the Fed (50bp in 1H19) and hence our expectation is for Indian real rates to remain wide and INR to outperform," Redeker writes, in a note to clients.

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