The Indian rupee: a curate’s egg
Despite a recent resurgence in covid-19 cases, the Indian rupee has rebounded in the past few weeks, notably because the Indian government resisted imposing a national lockdown, which would have had a dire impact on the Indian economy. Overall, this confirms that a key factor for the Indian rupee is the domestic growth outlook, which favours investment inflows (especially flows into Indian equities).
Along with foreign interest in Indian equities, recent current-account surpluses (thanks in large part to a decline in imports) mean that capital flows have been supporting the rupee. But as the economic situation normalises, the current account is expected to move back into deficit. In addition, we have a more conservative view on India’s economy than consensus, believing the recent surge in covid-19 cases in India will delay some government growth initiatives. While foreign investment flows held up during the latest surge, risks to the economic outlook may ultimately weigh on foreign capital flows. Overall, balance of payments dynamics should offer less support to the rupee in the coming months.
The fiscal year 2021 budget (which goes from 1 April 2021 to 31 March 2022), which will likely lead to a further deterioration in India’s fiscal balance, has not sparked concern among investors. Confidence in India’s growth potential and foreign investors’ interest in Indian equities are likely part of the explanation for this. This further suggests that the outlook for Indian growth is decisive for the rupee and that any growth disappointment because of the latest covid surge could weigh on the currency.
Overall, we would not expect the rupee to appreciate much further, as capital flows are likely to decline in the coming months, especially if the fall in covid-19 cases is slow and uneven. At the same time, we see limited scope for a significant depreciation of the rupee in light of elevated inflationary pressure, which could force the central bank to act. The Reserve Bank of India’s large currency reserves also make any sharp depreciation of the rupee unlikely. Our projections for the USD/INR rate are INR74.5 in three months, INR75.5 in six months and INR76.0 in 12 months.