The Fitch report cited three reasons for revision over the short-term:
First, the Indian rupee being an emerging market currency with structural fundamental vulnerabilities such as its current account and fiscal account deficits make it susceptible to sell-offs during periods of risk-off.
With around 65 percent of the global economy under some sort of lockdown or quarantine as of end-March, Fitch believes there is likely to be a global recession.
Moreover, relative to Europe and Southeast Asia, Fitch believes that the Covid-19 outbreak in India has just begun, and an increasing spread will weigh on the economic data over the coming months leading to lower investor confidence and rupee outflows.
Second, the relatively low number of Covid-19 cases in India so far, could raise suspicions and concerns among investors regarding the government’s management of the crisis and as such, would also weigh on risk assets.
Third, the Reserve Bank of India (RBI) is likely to implement steep monetary easing over the coming months using a range of measures across its policy toolbox, which could include USD/INR swaps, long-term repurchase (repo) operations, interest rate cuts, reserve requirement adjustments and even changes to its interest rate corridor.
The RBI has announced on March 18 that it would be injecting liquidity into the markets through the purchase of short-term notes and government bonds to ease bond yields which have spiked due to risk aversion.
“As higher government borrowing due to weaker revenue collection will also push up bond yields, risks to our monetary policy view are tilted towards even more easing measures to limit the rise in yields, which bodes poorly for the rupee over the near term.”
Drop in oil prices could limit depreciation
However, the drop in oil prices could help limit the extent of rupee depreciation, the report noted. India, which imports 80 percent of its oil needs, could see an improvement to its terms of trade as a result of the ongoing oil price war started by Saudi Arabia and Russia in early March. Since then, Brent oil prices have plunged from around $50/bbl to below $30/bbl. Fitch expects 2020 average Brent oil price to stay at $43.20/bbl.
Over the longer term, the rupee's overvaluation and structurally higher inflation relative to the US would exert downside pressure on the currency. Fitch has revised its 2021 average forecast of INR80/USD from INR75/USD previously.
The rupee’s real effective exchange rate (REER) index is trading 5.2 percent above its 10-year average, which suggests that the currency is mildly overvalued.
The report forecast inflation to average 3.1 per cent over FY2020/21 and FY2021/22 (assuming normal monsoon conditions).
Food and fuel prices tend to heavily impact inflation in India. Adverse weather during the growing season can easily lead to a surge in headline inflation due to poor crop yields even despite weak core inflation, it said.
From a long-term technical perspective, the rupee has broken support at INR74.45/USD, and is now trading at historical lows to the greenback.
“Given the existing risk off sentiment and no sign of an end to the Covid-19 pandemic, the unit may average well below our forecasts.”
(Writing by Brinda Darasha; Editing by Seban Scaria)
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