Rupee ducks slump in EM currencies, but crude, dollar threats loom

The rupee held its ground so far this year, even as emerging market currencies slumped on rising worries over the Chinese economy and US interest rates souring the sentiment on riskier assets.

However, going ahead, the Indian currency will likely see a tug-of-war between headwinds from high crude oil prices and firm interest rates on one side, and tailwinds from JPMorgan bond index inclusion and possible RBI interventions.

Emerging market currencies have slumped up to 30 percent this year against the US Dollar. Russian ruble has tanked around 30 percent against the dollar so far in 2023 when the Chinese yuan lost around 6 percent. The Indian rupee, in contrast, slipped only 0.5 percent against US dollar.

What’s driving emerging currencies down?

The expectation of the US Federal Reserve keeping the interest rates higher for longer amid signs of strength in the US economy and doubts about China’s growth outlook have boosted volatility in markets around the world. This has led traders to unwind bullish positions in emerging markets.

Additionally, a recent rally in crude prices, which hit a one-year high recently, is adding to the worries. The Brazilian real has managed to log gains, despite the slump in EM currencies. BRL has jumped around 5 percent against the USD so far in 2023, outperforming the INR, Chinese yuan and Russian ruble.

Headwinds for rupee

According to forex analysts, the rupee is likely to depreciate in the near term with the dollar firming up and crude oil prices soaring. The rising US government yields are also expected to hurt the Indian currency. Further expectation of better GDP numbers from the US would support the dollar to trade firm, which may be another hit for the rupee.

Tailwinds for rupee

International brokerage house JPMorgan recently announced to include India’s sovereign bonds to its Global EM Index and the index suite. The inclusion will take place on June 28, 2024, and will be staggered over a period of 10 months.

This is a structural change that could rerate Indian bonds and could have positive medium-term implications for the rupee. With India’s inclusion in the JP Morgan index, FPI inflows into debt are projected to rise.

“Some of the forex reserves accumulated due to index-related inflows will be required to keep the currency range-bound. We expect USD/INR in the range of 82-84 per dollar in FY25,” said Bank of Baroda.

Rupee to hold its ground?

The finance ministry expressed optimism about achieving a 6.5 percent growth rate in FY24, driven by improved corporate profitability, private capital formation, and bank credit growth, despite concerns over rising crude oil prices and a monsoon deficit. S&P Global Ratings maintained India’s growth forecast for the current fiscal year at 6 percent, citing global economic slowdown, monsoon uncertainties, and the delayed impact of rate hikes. This positive outlook may also keep the rupee buoyant amid emerging currencies’ slump.

CareEdge anticipates the USD/INR exchange rate to fluctuate within 82 to 84 in the second half of the fiscal 2023-24, gradually gravitating towards the lower boundary of this range. “The Federal Reserve’s hawkish stance, communicated during the September meeting, is expected to sustain elevated yields in the US Treasury market and maintain strength in the US Dollar Index (DXY) in the short term,” CareEdge said.

Rupee volatility to be mitigated

India’s current account deficit is expected to remain manageable in FY24. “Foreign Portfolio Investments (FPI) are poised for recovery, driven by robust economic fundamentals and the eventual moderation of UST yields and the DXY. We anticipate that RBI interventions will persist, serving to mitigate rupee volatility and imported inflation,” CareEdge added.

The weakness in the Chinese Yuan is expected to persist until China unveils substantial stimulus measures, and this is likely to exert downward pressure on the currencies of other emerging Asian markets. “Tight supply conditions are projected to keep oil prices elevated in the near term; nonetheless, we anticipate a moderation in oil prices in the absence of substantial stimulus from China and as the pace of economic growth in the United States begins to slow,” CareEdge said.