The sustained weakening of the rupee is likely to force the Reserve Bank of India (RBI) to hike interest rates and put Indian companies which rely on the US dollar debt to fund their operations on a sticky wicket, global rating agencies and investment banks said.
The Indian rupee has weakened around 13 per cent since the beginning of 2018. “If the rupee remains under pressure, the RBI might be forced to hike rates citing risks to inflationary expectations and second order impact of a weak currency,” said Radhika Rao, economist, Group Research, DBS Bank. “With inflation already rising, especially on the non-food part for both the CPI and WPI, higher fuel prices will mean that the RBI would have to take action on interest rates and there would definitely be another rate hike of at least 25 basis points,” Care Ratings said in a report.
According to Swiss bank UBS, in an alternative scenario where India continues to be affected by the headwinds of rising oil prices, capital outflows, populist spending and political uncertainty leading to financial stability concerns, a 50 bps hike (in repo rate) is likely for the rest of FY19. 10-year bond yields could stay elevated at around 8 per cent (vs. 7.75 per cent, it said earlier). “In a scenario where trade wars drag global growth and push commodity prices lower, India might benefit as a disinflationary environment lowers external stability risks. India is only a small part of the global supply value chain, suggesting limited impact on growth. Rates will likely be kept on hold in this case,” UBS said.
“As such, we also revise our year-end the rupee forecast to 73 (against 66 earlier), despite our modestly negative US dollar view,” UBS said. Global rating firm Moody’s Investors Service on Monday said a sustained weakening of the rupee would be credit negative for its rated Indian companies, particularly those that generate revenue in rupees but rely on US dollar debt to fund their operations and have significant dollar-based costs, including capital expenses. Annalisa DiChiara, Moody’s vice-president and senior credit officer, said, “Nevertheless, most rated Indian-based corporates have protections in place — including natural hedges, some US dollar revenues and financial hedges — to limit the negative credit implications of a potential further 10 per cent weakening of the rupee to the US dollar from Thursday’s rate.”
UBS said there are only five major emerging markets running a basic balance deficit and India is one of these. “This gap has been weighing on the rupee — down 13 per cent in 2018 — and we expect these pressures to sustain in FY19/20,” UBS said.