Indian Rupee to Remain an Underperformer says TD Securities - RBI in Focus

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- INR underperforms as investors sell Indian assets ahead of election.

- Underperformance is likely to define 2019 year says TD Securities.

- As concerns about RBI independence and rate policy weigh on INR.

The Indian Rupee is set to remain among the worst performing emerging market currencies for the foreseeable future according to analysts at TD Securities, who say lingering concerns about interest rate policy, the Reserve Bank of India's (RBI) independence and domestic politics will continue to weigh. 

India's Rupee has fallen by close to 3% against the U.S. Dollar so far in 2019 when most other emerging market currencies have had a whale of a time, rising by high single-digit percentages against the greenback in response to a landmark shift in Federal Reserve interest rate policy. 

Lingering concerns about the indpendence of the central bank under new governor Shaktikanata Das, a former government official, are partly to blame. While anxiety about the government's budgetary discipline ahead of a general election due later this year have also been at play too. 

Now markets are turning toward Thursday's RBI interest rate decision and statement, with consensus looking for the benchmark borrowing cost to be held at 6.5% for the current month. This means investors will take their cues from the accompanying statement and any new economic forecasts issued.

"If markets perceive the RBI to have succumbed to political pressure to ease, this could do more damage to the INR. We think an unchanged outcome will leave the INR to consolidate, whereas a cut will likely lead to a further fall," warns Cristian Maggio, head of emerging market strategy at TD Securities. 

Above: USD/ZAR rate shown at daily intervals.

Maggio told clients this week the RBI is likely to change its monetary policy stance to "neutral", from its current "calibrated tightening" setting, on Thursday. But he also warned there is a "not insignificant" chance the new governor could surprise the market by cutting India's interest rate to 6.25% in what would be a major fillip for the government ahead of this year's election. 

Government officials came into conflict with the RBI and former governor Urjit Patel late last year, prompting his resignation from the bank, as the finance ministry pushed for a higher dividend to the Treasury and and pressured policymakers to abandon some of their efforts to address a growing pile of toxic debt in the banking sector. 

Political pressure on the RBI is widely believed to have been geared at securing monetary support for the economy ahead of 2019's election and helping the government to plug a larger-than-expected hole in its budget that has resulted from increased subsidies paid out to rural farmers in recent quarters. 

But the pressure campaign and resignation of Patel has led to concern in the market about the independence of the bank, which is seens as an essential tool for keeping inflation under control and maintaining financial stability. The Turkish Lira crisis of 2018 demonstrates what can happen when central bank independence is compromised. 

"Unlike many other EM currencies the INR has not taken advantage of a softer USD and more benign Fed path," says Maggio. "The fact that it has not rallied in line with other EM high yielders likely reflects the fact that India has registered portfolio capital outflows over recent weeks, while oil prices are higher, amid concerns about fiscal slippage ahead of elections."

Above: Pound-to-Rupee rate shown at daily intervals.

Maggio says investors are selling Indian assets ahead of the election due in April or May out of concern that government economic policy ahead of the vote could prove harmful to returns. Higher borrowing is bad for the value of government bonds and can also weigh on exchange rates if debt comes from overseas.

RBI rate policy in the months ahead could also be a headwind too. The bank raised rates twice in 2019 to fight mounting inflation pressures that were stoked by a double-digit increase in the price of oil and currency devaluation. 

Now financial instability, regulations, higher interest rates and the U.S. trade war with China have all contributed to a slowing of the economy that is expected to reduce Indian inflation pressures going forward. 

This means the some time sooner or later, RBI governor Das could feel compelled to cut Indian interest rates, which would be bad for the value of the Rupee over the coming months. 

"We are generally constructive on the INR over the months ahead, but by this we mean that the currency will gradually depreciate. We forecast USDINR to reach 72.90 by end 2019," Maggio says, projecting what would make for a 6% annual increase in the exchange rate. 

The USD/INR rate was quoted -0.10% lower at 71.60 Tuesday but has already risen 2.96% for the 2019 year, while the Pound-to-Rupee rate was -0.33% lower at 93.12 but is up 4.97% for the year-to-date. 

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