Rupee Forecast to Recover vs. Dollar but More Losses seen against Pound by SEB

- USD/INR has topped out but GBP/INR to keep climbing. 

- RBI to keep raising interest rates, lending support to the INR.

- Indian economy to pick up pace through 2020, further supporting INR.

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The Indian Rupee has bottomed out at historic lows against the US Dollar and is on course to stage a modest recovery from hereon, according to analysts at Skandinaviska Enskilda Banken (SEB).

The Scandanavian lender says India's Rupee can resist further depreciation during the months ahead thanks to higher interest rates and a robust outlook for economic growth which, for investors, will compensate for a deteriorating trade balance and elevated inflation risks stemming from higher oil prices. 

This call comes as the Rupee trades at a 10% loss against the US Dollar for the 2018 year and a 5% loss against Pound Sterling.

An exodus of investor capital from emerging markets brought about by a strengthening US Dollar which has far-reaching negative implications for developing world economies is seen as the main driver behind the Rupees decline. 

"For a long time, India benefited from a downward trend in energy prices, when now that oil prices have climbed again, the economy is under pressure on several fronts. The country’s trade deficit has widened and the government has cut fuel taxes in order to ease the impact on the private sector," says Andreas Johnson, a currency strategist at SEB. "With future oil prices expected to be around USD 70-80/barrel, however, the negative impact on the government budget and economic growth will be limited."

Prices of oil futures have risen by more than 13% in 2018, to around $75 per barrel for Brent oil and $68 for WTI, which has forced up inflation the world over. But given this increase comes on top of a 10% fall in the value of the Rupee relative to the US Dollar, the inflationary impact on in India has been larger than it has in some other parts of the world. 

However, the adverse impact of the this year's increase in energy costs does not stop there.

It has also fed a deterioration of the Indian trade deficit, which widened to $18.02 bn during July, up from $11.45 bn during the same period one year before. This means the value of Rupees sold on international markets in order to buy other currencies and pay for imports has increased substantially in 2018.

For investors, that is a problem because it leaves the country in need of increased capital flows to prevent a deterioration in the current account balance, right at a time when investors are shunning emerging markets.

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A Saving Grace

However, with the Reserve Bank of India (RBI) having raised its interest rate twice in 2018 to counter the rise in inflation, the exodus from India and its resulting pressure on the Rupee is now expected to ease. 

"The currency is being hurt by higher oil prices, worries about central government finances and the trade deficit. Recently the rupee has also been pulled down by market turmoil related to Turkey, but the risk of further depreciation is limited due to India’s tighter monetary policy and favourable economic growth outlook," says Johnson. 

The RBI raised both of its main interest rates earlier in August, taking the repo rate up to 6.5% and the reverse repo rate up to 6.25%, barely two months after the previous hike. The bank cited the 2018 increase in inflation as being behind its decision to tighten monetary policy for the first time since 2014.

Indian inflation rose to 5% during June while core inflation, which removes volatile food and energy items from the goods basket, rose to 6.4%. It then fell back to 4.2% during July but the core measure remained above the 6% threshold. But the RBI is required to keep inflation at 4%, plus or minus 2% in either direction, over the medium term.

Johnson says Indian inflation should average around 4.6% for 2018 and 4.8% for 2019 and 2020. Meanwhile, the economy is forecast to grow by 7.5% in 2018, up from 7.1% in 2017, before expanding by 7.8% in both 2019 and 2020.

Forecasts for the Rupee

As a result, Johnson and the SEB team predict more policy action from the Reserve Bank of India during the months ahead, which could offer further support to the Rupee. 

"Although CPI inflation fell unexpectedly fast in June, the statistics are volatile and various factors will contribute to continued price pressure. Our forecast is that the RBI will hike its key rate twice in 2019 and once in 2020 to 7.25 per cent," Johnson writes, in SEB's latest monthly outlook. 

Changes in interest rates, or hints of them being in the cards, are only normally made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

SEB forecasts the USD/INR rate will fall to 70.0 before the end of 2018 and that it will then decline back to 68.5 in 2019 and to 68.0 in 2020. However, the bank predicts the Pound-to-Rupee rate will rise further over coming quarters, to 92.95 for December 2018, to 100.68 in time for 2019 and to 108.84. 

The USD/INR rate was quoted 0.45% higher at 70.52 during early trading Wednesday while the Pound-to-Rupee rate was 0.51% higher at 90.79.

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