A boon and bane for India’s rupee

The boon – Oil Price

An outstanding Asian currency this month was the Indian rupee (INR) that went up 4.4 percent month-to-date against the U.S Dollar. At 70.6 the USD/INR has retraced a chunk of the 15 percent depreciation that drove the pair above 74.0 in the first 10 months of the year. The reversal of fortune for the currency can be explained by the more than 30 percent collapse in the crude oil price since October.

The expectation of slower global growth amidst an intensifying Trade war and increased supply are depressing the oil price ahead of the Organization of the Petroleum Exporting Countries (OPEC) meeting in early December at which US – Saudi Arabia diplomacy will weigh heavily on future supplies.

Aside from the falling oil price boon and the broader U.S Dollar weakness, India’s economic dynamics have hardly changed in favour of the INR. The GDP data forecast for the second quarter of 2019 is due tomorrow and is expected to reinforce the fact that growth has peaked and the slowdown has begun. The contributors to the slowdown have been the high base effect, weakening exports and private consumption, and increasing drag from net trade. In addition to this are the persistently tight banking system liquidity and tough lending guidelines for public sector banks dragging investment demand.

The median consensus expects a GDP growth of 7.4 percent but anything weaker will be bearish for the local financial assets, including the INR.

The current account and the government budget are the twin-deficits (which possible could get even worse) that make up the key economic resistance for the INR appreciation. The cumulative budget deficit forecast in the first half of 2019 was 19 percent higher than a year ago. The pressure on public finances was obvious from recent pressure by the government on the central bank for more funds. In addition to, on the external front, the financial year-to-date trade deficit of $111bn is 26 percent wider on the year, with more than half of the widening coming from oil trade.

The benevolent inflation backdrop, which is perplexing in view of INR’s murky performance, has allowed the Reserve Bank of India to hold the line on policy interest rates. That being said, the wide fiscal deficit will eventually lead to more inflation while crowding out of private sector investment which will also weigh on GDP growth.

The bane – Politics

Above all, politics is likely to decide the path for the INR in 2019. The political heat is already rising as the elections currently being held in five states will set the tone for the national elections scheduled in May 2019. Considering the public wrath following chaotic demonetisation in late 2016 and the Good and Services Tax in mid-2017, it will be a tough task for the Modi government to retain power for another term.

Cracking the longest appreciation streak in two years the USD/INR started trading this week on the weaker side. The pair is not drifting far from the current level as the year draws to close, though the bias will be more on the weaker than stronger side depending on the outcomes of the state elections.

In the meantime, the swelling political uncertainty in the run-up to general elections leads to an anticipation of the INR weakening. Once the political overhang lifts it is expected that a steady consolidation in currency levels will occur.