India Insight:Don’t fret the falling rupee (USD/INR)

The repricing of global risk on concerns regarding slowing growth in China,risk of further RMB depreciation and falling global commodity prices (mainlyoil) has resulted in significant capital outflows from emerging markets,including India, and has bought external stability risks to the fore. Indeed, theIndian rupee (USD/INR) has depreciated by 2.8% since the start of CY16 afterbeing among the best-performing EM currencies in CY15. India’s FII-equityoutflows have been acute, amounting to US$1.2bn since the start of Jan-16.

Current weakness in INR: sentiment over fundamentals?

Don’t compare this with 2013 taper episode; India’s macro fundamentalshave strengthened significantly: The most common question that we havebeen getting from investors is the likelihood of sharp depreciation pressure onIndian rupee (USD/INR) on global headwinds. In 2013 when the Fed indicatedtapering, the Indian rupee depreciated by ~28% against the US$ betweenMay-13 and end-Aug-13. We believe India’s fundamentals have improvedsignificantly since then in terms of macro stability risks on policy initiatives andthe building of possible buffers against external shocks. We expect India’sCAD to remain manageable within 1% of GDP in FY16 and FY17. Foreignexchange reserves at US$349bn (as of 8th Jan) seem adequate to withstandvolatility in the case of global risk aversion. The government has been makingpolicy efforts to attract more capital flows by liberalising FDI and other debtflows. CPI inflation has also moderated to close to RBI’s comfort zonecreating scope for more policy easing. We continue to expect a modestcyclical recovery in FY17 GDP growth. (2016 outlook – bumpy ride to recovery)..but it is not immune.: While we believe India is ‘better placed’ within EMsto face global risk aversion, it is not ‘immune’. Even as India’s macrofundamentals are much better than before, the increased global integrationand still-stretched external vulnerability indicators implies that it will also bearthe brunt as global volatility increases even as the impact would be limited.

Modest depreciation bias in rupee (USD/INR) in FY17: We the believerupee is still in overvalued territory on REER basis despite the recentdepreciation seen against the US$ since the start of CY2016. We believe thelikely path of USD/INR in FY17 will be more driven by external than internalfactors, including the extent of RMB devaluation (our China economist isbuilding in 5-7% depreciation in RMB against the US$ in 2016), the pace ofFed normalising interest rates (25bps/quarter until 2% is reached in mid-17),movements in global crude oil prices and domestic reform momentum. Whilethe volatility in USD/INR could increase in the next 1-2 months onuncertainty regarding China’s FX policy and/or global risk aversionresulting in a further 2-3% depreciation from the current levels, we don’tsee the trend being sustained. We expect the currency market tostabilize as investors start focusing on macro fundamentals, helping theUSD/INR settle towards our base case range of 66-68.5 range in FY17.

We expect the RBI to intervene in the currency market to manage the neartermvolatility for a favourable transition. However, it needs to be noted thatany higher than expected RMB depreciation and/or continued strengthening inthe dollar index would weigh on commodity prices, cause EM capital outflowsand have an impact on AxJ currencies, including the INR.