Indian Rupee Forecast: Will USD/INR Reverse As CPI Brings RBI Cuts In Focus?

Despite what has been a crushing year for the US Dollar, it is looking to wrap up 2021 with a win against the Indian Rupee. In fact, INR is down about 3% against USD year-to-date (YTD) even though the Nifty 50, India’s benchmark stock market index, set record highs. This is also despite the Reserve Bank of India (RBI) ending up with some of the highest main lending rates post-Covid within the Asia-Pacific region.

In comparison, neighboring ASEAN currencies turned net positive against USD. Might this trend reverse course and what are some risks to watch for in the near-term? Heading into 2020, India was already in a vulnerable economic position before Covid, with inflation running high thanks to soaring onion and garlic prices. This was mixed with a wobbly banking sector as growth slowed, raising the risk of stagflation.

 

When Covid struck, the RBI eased policy in an emergency meeting as it also embarked upon unconventional measures. However, it did not get very far with the former as inflation remained persistently above target. A higher domestic fuel tax also did not help. Yet, the global appetite for higher returns, especially in emerging markets, still resulted in strong capital inflows into equities.

To soak up this demand, and more importantly keep the Rupee under pressure, the RBI gathered foreign exchange reserves at a hungry pace. As a result, India became the 5th-largest FX reserve holder this year. Relatively high inflation, and plunging short-term interest rates, sent capital flowing out of local government debt at record levels – see chart below.

DOWNWARD PRESSURES ON THE INDIAN RUPEE

Indian Rupee Forecast: Will USD/INR Reverse as CPI Brings RBI Cuts in Focus?

Going forward, Indian inflation is expected to ease towards the midpoint of the RBI’s target range (2-6%) by the end of 2021 – see next chart below. More importantly, this could open the door for much-needed monetary policy easing on top of fiscal support already worth about 15% of GDP. The government has made it clear it is not concerned with rising debt levels for the time being.

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