The Indian Rupee Faces "Another Turbulent Year" says ING Group

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- USD/INR to appreciate ahead of May general election says ING Group.

- As Modi fights for reelection and market fears for the budget deficit. 

- But says Pound-to-Rupee rate will rise steadily throughout the 2019 year.

The Indian Rupee is facing another turbulent year and will likely depreciate significantly in the run up to May's general election, according to analysts at ING Group, who say external challenges and the prospect of a change in the government's economic policies will unsettle markets in the months ahead. 

Indians go to the polls in May 2019 and after Prime Minister Narendra Modi's Bharatiya Janata Party (BJP) received a drubbing in several regional elections at the end of 2018, the country could be headed for a "hung parliament" or an outright regime change in New Delhi. 

Fears are that this will encourage a less disciplined approach to the public finances over the coming months with increases in government spending seen as likely which, when combined with a testy inflation outlook, could spell bad news for the currency and financial assets. 

"Markets are bracing for intensified political risk as a general election  looms in May. Losses by Modi’s incumbent party in recent state elections raise the prospect of an indecisive vote and a coalition government. Repricing for this will exert upward pressure on government bond yields and the USD/INR exchange rate," says Prakash Sakpal, an economist at ING Group. 

Above: USD/INR rate shown at daily intervals.

Sakpal says India's BJP party could well emerge the winner from May's general election but that a likely loss of seats in the parliament could still leave it unable to form a government, which might then see the opposition Congress Party come to power.  

The Congress Party was relegated to political obscurity by Modi's BJP in the 2014 general election but rose from the dead in December when it won narrow majorities in three regional ballots, which has led to scrutiny of support for the BJP in rural areas where low commodity prices and stagnant farming incomes have fuelled discontent with the government.

It was that discontent in rural Indian heartlands that led the Indian government to hike the minimum support price it pays to farmers of rice crops by 13% last year. This has driven the budget deficit even wider than it was and stoked expectations of higher inflation, which was part of what prompted the Reserve Bank of India (RBI) to raise its interest rate twice last year. 

"Growth will outweigh fiscal discipline as the Modi administration pushes for a second term. As such, after an overshoot of the deficit in the last financial year and more likely again in the current year, hopes of any fiscal consolidation receiving prominence in evolving macro policy are misplaced," says Sakpal.  

Higher government spending and a wider budget deficit ahead of the election will fuel domestic demand for imports and antogonise the trade as well as current account balances. 

A widening trade deficit saw an increase in the number of Rupees sold on international markets last year, as Indians must exchange Rupees for other currencies in order to import goods. 

This came at a time when government was borrowing larger amounts of money from international markets and as investors fled the emerging world due to concerns over financial stability, which led to a widening current account deficit that has turned investor sentiment even further against India's currency. 

Above: Pound-to-Rupee rate shown at daily intervals.

Sakpal says a recovery in oil prices and strong domestic demand will ensure Indians continue to import increasingly larger amounts of goods in 2019, putting downward pressure on the Rupee, while faltering global growth continues to weigh on exports. And that's in addition to other challenges faced by the Rupee. 

"Net foreign portfolio flows swung from a brief inflow toward the end of 2018 to an outflow starting 2019. This does not just reflect the politics. The troubles at non-bank finance companies are far from over with media reports of another infrastructure lender defaulting on its debt due this month. We see no near-term respite from negative foreign investor sentiment," warns Sakpal. 

Sakpal forecasts the USD/INR rate will soon retest the 73 threshold it breached back in 2018, despite trading at 71.15 on Tuesday, as investors dump the Rupee ahead of the May election. 

However, he also projects that before year-end, the exchange rate will have come back to earth and that it'll see out 2019 around the 69.00 level. The Pound-to-Rupee rate is projected to rise from 93.67 Tuesday to 94.16 by the end of March, and for it to see the curtain close on 2019 at 97.91.

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