The rupee is one of the world’s worst performing currencies of 2018; down 13% against the dollar since the beginning of the year affected by political and economic headwinds that is also pushing the stock market lower leading to capital outflows.
There are definite reasons for the rupee falling; including rising oil prices, a widening current account deficit and broader emerging market concerns. India is only economy out of the five major emerging market countries running twin deficits. The country’s external balances is a key factor influencing rupee weakness and we expect these pressures to continue throughout FY2019/2020. A weaker rupee is bad news for Indian businesses that generate rupee revenue but fund debt in U.S. dollars thereby increasing dollar-based costs and capital expenditure.
Adding to concerns is the state of country’s finances leading to financial instability. Lower GST collections are putting a strain on revenue thereby increasing the already high fiscal deficit. The price of imports are on the rise with oil and non-food registering the biggest gains adding to higher inflation. General elections are due in April or May next year and the likelihood of populist spending will be high draining the government of further capital. Therefore, with rising import prices, capital outflows, populist spending and political uncertainty leading to financial stability concerns, this is putting pressure on the Reserve Bank of India (RBI) to increase interest rates and we expect a 50 basis point hike within the rest of the 2019 financial year.
However, it is not all bad news. A weaker currency makes Indian exports more competitive which may lead to higher corporate profits and help narrow the current account deficit. In relation to an escalating trade war between China and the U.S., given India is only a small part of the global supply value chain, we would expect minimal impact on economic growth. Commodity prices would fall, including the crude oil prices, benefiting the country and interest rates would not need to rise.
We expect the rupee to end the year at 73 against the dollar and economic growth to slow to 7% to 7.3% in the second-half of this year with an overall full-year of growth of 7.5%.