Indian Rupee Forecast to Depreciate Further, Even after an August Interest Rate Rise at the RBI

- Trade deficit and rising oil price a growing threat to Rupee. 

- INR set for fresh 2018 lows warn analyts.

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The India Rupee is set to notch up fresh lows later this year, according to forecasts from multiple analysts, while interest rate rises from the Reserve Bank of India will merely serve to stem the pace of decline.

A strong Dollar and rising bond yields have driven international investors out of emerging markets this year, pressuring all emerging market currencies, at the same time as rising commodity prices and a robust domestic economic performance have compelled Indians to begin selling the Rupee too.

India's economy grew at its fastest pace for two years in the final quarter of 2017, with GDP rising an annualised 7.7% and holding this pace first quarter of 2018. However, this saw Indians buying more goods from overseas and, in the process, selling the Rupee on international markets.

Moreover, oil prices have risen by around 15% during the year-to-date, to trade at $69.05 Monday, which means Indian companies and consumers have had to dump even more Rupees on the market in order to keep the proverbial lights on.

As a result India's trade and current account deficits, which reflect real world supply and demand for a currency, are widening. It is this that, in the absence of corrective government policy, is expected to push the Rupee even lower still during the rest of the year.

"A US$16bn monthly trade deficit is commensurate with a current account deficit of 2.8%-3% of GDP, which will be challenging to finance in the current global environment, particularly given portfolio outflows from India and emerging markets more generally," says Sajjid Chinoy," chief India economist at J.P. Morgan. "India needs a policy mix of “expenditure-switching” and “expenditure-control” to prevent external imbalances from becoming unsustainable."

India's trade deficit rose to a 61 month high of $16.6 billion in June even after imports of oil and gold are removed from the numbers, which means India imported significantly more goods than it exported during the month. This trend is forecast to continue, placing continued pressure on the Rupee.

"The $157bn annual trade deficit FY2017-18 was the largest in the last five years and little under half of that, $70bn, was from the oil trade. With trade war sentiment weighing on future exports and rising oil prices, and strong domestic demand boosting imports, we're looking at another year with a large trade deficit in FY2018-19," says Prakash Sakpal, an economist at ING Group.

Chinoy and the J.P Morgan team say rising levels of domestic inflation and a widening trade deficit make a good case for more "monetary tightening" and are forecasting the Reserve Bank of India will follow its surprise June rate hike with two more interest rate rises before the year is out. This is a traditional policy response to inflation but will also have the effect of supporting the Rupee.

A stronger Rupee may then help contain the swelling trade and current account deficits by stemming the increase in prices of imported goods. Changes in interest rates, or hints of them being in the cards, impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

The Reserve Bank of India already announced a surprise interest rate rise back in June, taking the cash rate up to 6.25%, although increasing numbers of economists are now forecasting further rate hikes to come. The Capital Economics team predict Indian interest rates will rise to 6.75% before the year is out, after having correctly predicted the June increase.

"This has helped the INR to some extent, turning it from an Asian underperformer earlier in the year to an outperformer in the recent sell-off. But there was no end to the weakening trend that’s likely to persist in the near-term as the trade war risk works its way through the actual trade figures," says ING's Sakpal. 

Indian inflation rose to 5% during June while core inflation, which removes volatile food and energy items from the goods basket and so is seen as more representative of domestically generated inflation pressure, rose to 6.4%. The RBI target is to keep inflation at 4%, plus or minus 2% in either direction. The ING team have noted these developments too.

"With inflation poised to overshoot the RBI’s forecast, another rate hike at the next policy meeting on 1 August looks like a done deal. That’s not all. We have added one more rate hike at the October meeting to our policy forecast, taking the policy rate to 6.75%," Sakpal writes, in a recent briefing. "We now see USD/INR trading toward 71.5 by end-2018 and further to 72.8 by mid-2019."

Sakpal and the ING team are not alone in forecasting more rate hikes and further losses for the Rupee during the months ahead.

The J.P Morgan team are looking for the USD/INR rate to rise to 70 by the end of 2018 and 71.50 by the middle of 2019.

They also forecast the Pound-to-Rupee rate will rise to 95.77 before year end and that it will then climb to 99.28 by the middle of 2019.

Analysts at TD Securities also recently warned of further Rupee weakness ahead and are looking for the USD/INR rate to rise 2.1% to 69.97 by the end of 2018 before climbing further, to 71.28 in 2019.

The USD/INR rate was quoted 0.10% higher at 68.82 Monday while the Pound-to-Rupee rate was 0.26% higher at 90.46.

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