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With the rupee sliding to a record low by breaching the 90-mark against the US dollar, India is essentially seeing a capital flows-driven weakness cycle, which is probably led by the anxiety on the growth front, the impact of the unfinished trade deal, and similar such factors, Rahul Bajoria, Head of India and ASEAN Economic Research, BofA Global Research told The Indian Express. In an interview with Aanchal Magazine, Bajoria said the key difference for the rupee slide in this phase is that it is not accompanied by widening current account deficit, as was the case during earlier periods of weakness — taper tantrum, or 2018. The rupee will remain under pressure in the next few weeks because now that a big figure has been breached, the pressure on RBI to hold a particular level is less, he said. Edited excerpts:
What is the impact of this rupee depreciation at the macro level? Some are saying that this will be a shock absorber. What are the pros and cons of such depreciation?
The Indian rupee’s weakness mirrored the DXY (US dollar index) in the first half of the year, but its decline has become more pronounced in the second half. This shift is without any significant inflation concerns. While depreciation will inevitably add some inflationary pressure, inflation is not a very big concern within the system now. That, in turn, lowers the likelihood of second-order negative shocks that might otherwise accompany a move of this magnitude.
A year ago, the rupee was around 84.70 against the US dollar, and on December 3 it was at 90.19. So, it has been a 6.5 per cent move, which makes it weaker relative to every other currency in the region. But I still think it is not that debilitating from a spot standpoint.
To your point on whether it is a shock absorber — I think it is. If we were to go back and compare it to periods of rupee weakness — the taper tantrum, or the 2018 weakness period — they were driven fundamentally by widening current account deficits (CADs), which is not the case now. We may have had a couple of bad prints on the trade side, but by and large that would be seen as a function of gold imports. What we are seeing in India now is essentially a capital flows-driven weakness cycle to a large extent, which is probably driven by the anxiety on the growth front, the impact of the unfinished trade deal, and similar such factors.
A lot of external factors are at play…
While a lot of external factors are driving this weakness, the rupee has lost a lot of value in real effective exchange rate (REER) terms, which historically does have a tendency to course correct. Even in 2022, if you look at the last round of material weakness when we had seen the rupee go from 71 to 73 to all the way beyond 80 (against the US dollar), it has a tendency to then appreciate or stabilise at those levels.
And I don’t think the underlying economic conditions — whether they are related to the CAD, fiscal management, or inflation management, or interest rates — are pointing to the degree of loss of confidence within the system that the rupee will lose value materially from the current juncture. In my view, the rupee weakness is more a confluence of flows plus the circumstantial, and the pressure that’s now built up around big-figure change.
The way the Reserve Bank of India (RBI) has managed this cycle, it feels like the central bank is no longer intervening with the kind of intensity that they probably were earlier. So, it is almost a policy choice to let the rupee relieve some pressure because the intervention was quite heavy, at least for the time being. The forward book has been turning more negative, as was evident in the latest October data that came out from IMF. So, it is like the RBI kind of letting the automatic stabiliser work to a certain extent.
Inflation is not a concern right now nor even CAD so much. And capital flows are driving this situation more than earlier episodes of rupee depreciation…
Typically, if you look at the past cycles of FX weakness in India, every 5-6 years this happens. So, it is not anything extraordinary, which is going on. But what happens typically is that if your economy cyclically picks up, you tend to see the current account widen first. So, the amount of money you need to finance the current account, that requirement goes up. Depending on whether capital flows are there or not, it tends to create periods of higher volatility. I think in the taper tantrum we went to a period where the FX weakness was much less protracted than what India is used to whenever you’ve seen the cyclical pickup. This is the reason why this feels a little bit unusual because we are seeing FX weakness without a meaningful widening, or at least an expectation of a persistent widening in the current account deficit. That is why it feels a little bit different in this particular cycle.
I still feel that this is ultimately a function of capital flows — if that comes back and when do they come back, which will be the biggest delta difference that will come about. But the rupee itself has been allowed to adjust because that’s in a way, the right policy to pursue.
This, ultimately, I think, is largely a manifestation of external problems. It will also get resolved when external flows come back or within the system. In my view, the CAD is, not to a large extent, driving this weakness. There are factors like higher gold imports, maybe elevated Russian oil imports in the month of November, but that’s a temporary thing. It’s not that India is going to start buying $10 billion of gold every month, that’s not going to be the case. It’s more of just the external backdrop specific to India being challenging and some of the pressure points are being relieved by letting the rupee move around at the margin — which is the right policy again.
How do you see the impact on inflation? It is seen as the biggest risk when currency weakens, but right now, it’s already at record low levels.
You will find at the margin things will be more expensive. The largest source of imported price inflation in India, typically speaking, comes from things like crude oil, fertiliser prices or basically the derivatives of energy products. And with oil having declined more than Indian rupee this year, generally speaking, your import costs are not likely to increase on a relative basis. But again, there is a limit. For example, if you are an intermediate goods importer from Europe, the crosses have weakened a lot more. The Euro-INR, Sterling-INR (exchange rates) have gone up a lot more. But you can also turn it around and say that the exporters at the margin — the IT companies, the tourism side, the exporters of labor-intensive products — (stand to) benefit. While this helps at the margin, I don’t think that is the underlying objective of a weaker currency. That’s not what is going on.
On the growth side, exports will gain from a weaker currency, like you said. But do you see any downside risks to growth that you need to watch out for?
Not immediately, since weaker FX is generally identified as a bit of a supporter of growth because typically it will lower imports and increase exports. In principle, that’s a very tautological point. So, to answer your question: not immediately, but obviously if it hurts, say, your ability to import new capital machinery; you can create hypothetical scenarios, but conventional logic says it’s generally a growth support measure. So, I would think by and large this will be neutral for India. Its immediate macro impact is primarily through the sentiment channel, not necessarily through the growth or inflation channel.
How do you see the way ahead for the rupee?
Ultimately, what helps restore the efficacy of FX and flows is growth, purely just growth. We have upgraded our 2026 outlook for Nifty, we now expect it at 29K. We are not saying it’s going to be spectacular growth, but we are also saying that, look, don’t expect there to be terrible numbers coming through anymore.
It is very hard to give a level for rupee because we are in, I would say, slightly uncharted territory. It depends on a number of factors. If a trade deal happens tomorrow, one would anticipate that rupee sentiment will improve. But if a trade deal remains elusive, then the confidence around the rupee will remain fragile. This is not something we can predict. This can only be seen in real time.
In the next few weeks, the rupee still remain under pressure because now that a big figure has been breached, the pressure on RBI to hold a particular level is less. The degrees of freedom to manage the currency should increase in principle.
