Image © Reserve Bank of India
- INR takes RBI's 0.35% cut in stride but losses ahead, analysts say.
- RBI set to cut further amid fears for Indian and global economies.
- Strong USD, falling CNY and Kashmir to weigh further on the INR.
- Commerzbank and ING Group both forecast gains for USD/INR rate.
The Rupee was steady on Wednesday after having taken a larger-than-expected interest rate cut from the Reserve Bank of India (RBI) in its stride, although analysts at Commerzbank and ING Group say the Indian currency is likely to weaken into year-end.
The Reserve Bank of India cut its interest rate by 35 basis points to 5.4% Wednesday in an effort to support the Indian economy amid a slowdown in global growth. The bank says this and escalating tensions between the U.S. and China pose downside risks to the economic outlook.
Indian inflation was described by RBI Governor Shraktikanta Das as "benign" and is forecast by the RBI to remain within its target range of a 2% deviation in either direction from the 4% level. The main inflation rate was just 3.2% in June and the RBI forecasts that it'll remain below 4% all year.
"The markets took RBI’s creative rate cut in its stride," says Charlie Lay, an analyst at Commerzbank. "The global search for yield may continue to see inflows into INR assets. However, this will also largely depend on the broader risk picture. We remain cautious on the near term outlook for INR. Our bias is tilted to the upside for USD-INR towards 72.00 by year-end."
Above: Pound-to-Rupee rate shown at hourly intervals alongside USD/INR rate (orange line, left axis).
Markets care about the Reserve Bank decision because changes in interest rates, as well as the outlook for them, can have a significant influence over international capital flows as well as speculative short-term trading activity. Capital flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from a currency. Rising rates have the opposite effect.
Governor Das had hinted at an International Monetary Fund conference in April that the RBI could consider interest rate changes, which are normally made in increments of 25 basis points and 50 basis points, of an unvonventional size. Commerzbank's Lay forecasts the bank will cut its interest rate again this year, by a total of 50 basis points, leaving the cash rate at 4.9%.
Further steep rate cuts from the RBI should be bad for the Rupee but with interest rates elsewhere in the world so low, Lay says that India's relatively high cash rate should draw capital flows toward India, limiting the Rupee's losses in the process. Analysts at ING Group have offered a similar vew, although they're also warning of risks posed to the Rupee by the U.S. trade war with China and resulting weakness in the Renminbi.
"Judging from the limited negative impact on the INR from the RBI rate cut as of writing, we can only conclude that the cut was already largely priced in. That said, the larger than expected rate cut today may well foreshadow continued policy easing and further currency weakness ahead. As such, we are revising our end-2019 forecast for USD/INR from 70.0 to 72.0," says Prakash Sakpal, an economist at ING.
Above: Pound-to-Rupee rate shown at daily intervals alongside USD/INR rate (orange line, left axis).
Wednesday's rate cut comes at a time when financial markets have been on edge over the prospect of the U.S.-China tariff fight turning into a currency war after the People's Bank of China (PBOC) allowed the Renminbi to depreciate this week. It fixed the midpoint of Wednesday's trading band for the USD/CNY rate at 6.9996, close to the psychologically important 7.0 level the market has traded above all week.
That matters to the Rupee for many reasons, with the simplest being that emerging market currencies tend to move in tandem with each other. Weakness impacts developing economy currencies the most when the Dollar is strong and investors appetites for riskier assets are waning, which they have been this due to fears over what might become of the U.S.-China relationship and where that might take the global economy.
"The emerging-market turmoil this week triggered by a spike in the USDCNY exchange rate above 7 saw the INR reasserting its status as Asia's weakest currency. And the outlook for the currency has turned more negative still with the move by the government this week to withdraw autonomy from the disputed state of Jammu and Kashmir - escalating border tensions," Sakpal says.
The U.S. has already declared China a "currency manipulator" as a result of the PBOC's decision and markets are increasingly conscious of President Trump's rhetoric around the value of the U.S. Dollar and his calls for the Federal Reserve(Fed) to set its interest rate policy to ensure the greenback weakens. A strong Dollar makes imports cheaper for Americans to buy and risks exports by making those more expensive for other countries to buy.
Meanwhile, the Indian government has revoked the autonomous status of the Kashmir province, prompting protests from Pakistan and raising tensions between the two nuclear armed powers who've a complex history with each other as well as Kashmir. Tensions at the India-Pakistan border saw both come to blows this year, with bombing raids seeing an Indian pilot captured.
"At the end of the day, as long as the Chinese yuan weakens against the USD, the US won't be happy and would accuse China to have manipulated its currency. In the meantime, China is aware of that and is seemingly prepared to pay the price of such a move," saysd Hao Zhou, an analyst at Commerzbank. "It is hard to see any meaningful de-escalation unless either side feels the real pain. So in my opinion, there is no limit on the trade tensions for now, and the market needs to prepare for more volatility."
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