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A weakening rupee is the “perfect medicine” to counter the problem of elevated tariffs currently, according to PRANJUL BHANDARI, HSBC’s Chief India Economist/Strategist and ASEAN Economist. In an interview to The Indian Express after the rupee breached the 90-per-dollar mark for the first time on Wednesday, Bhandari said the shock of the US’ 50 per cent tariff on India is reflecting in the trade deficit and a combination of a widening current account deficit and weak capital inflows is exerting pressure on the Indian currency. However, a trade deal with the US and the Indian government becoming “very serious about multiple reforms” could be important catalysts and provide positive triggers for inflows and the rupee. Edited excerpts:
There are a lot of factors (behind it) and a lot of them have had to come together, but what’s different right now is the trade deficit. In October, it was $42 billion and …it has been north of $30 billion for a few months. So, the current account deficit (CAD) widening after a very long time has played a big role (in the rupee’s slide).
On the capital flows side, net foreign direct investment (FDI) has been weak and portfolio inflows haven’t been very exciting. So, you have both — a widening trade deficit and capital flows that have been weaker than people would have liked. This has made the balance of payments a little more fragile and that’s what’s really bearing on the rupee right now.
The 50 per cent tariff is over double of what has been put on ASEAN countries, which puts India at a relative disadvantage and the trade deficit is reflecting that as our exports are weakening quite a lot. This has been a global exogenous tariff shock.
Whenever you have such shocks, they need to be addressed. I think the best way to do this is to allow the currency to depreciate. When the currency depreciates, exports become more competitive. Tariffs make your exports uncompetitive and your currency depreciating counters that. So, in a way, it’s the perfect answer to the problem.
In all the work that we have done in the past, we have noticed that exports of both goods and services react positively to currency depreciation; in fact, services exports respond even more than goods exports. Given that services exports have been our comparative advantage lately and we are not seeing protectionism in services trade the way we are seeing in goods, letting the currency depreciate could also be quite good for our services exports going forward… This is the perfect medicine to the problem of elevated tariffs at this time. From that perspective, I would agree with the Chief Economic Advisor V Anantha Nageswaran that I am not overtly worried about a gradual depreciation.
We would have to see when the deal happens and its details. But if it’s announced one month down the line and the tariff rate falls from 50 per cent to, say, 15 per cent, that would be a bigger reduction than markets have priced in and could lead to a step appreciation in the currency for both direct and indirect reasons. The direct reason would be that the export drag would soften, while the indirect reason is that FDI might improve again. Over time, if on the back of the trade deal India’s growth improves and foreign investors start putting money back into the market, that could again sustain some positive sentiment around the rupee. So, the trade deal could be an important catalyst.
But there are other things that can also go right — for example, if the government suddenly becomes very serious about multiple reforms. We have already seen the labour codes being announced. If that is followed up by other reforms — there is a deregulation drive that’s going on — and if there is some impact from them, they would also be a positive trigger for inflows and therefore the currency.
I can’t comment about the end of next year because there are so many moving parts. If there is no trade deal, then gradual depreciation could continue from these levels. If there is a deal, the rupee could quite easily come below 90-per-dollar again.
Till about two weeks ago, when people were asking me about my forecast for the rupee, I was saying 87-91 per dollar for the next few months — 91 per dollar if we don’t get a trade deal and a jump up to 87 per dollar if there is one. Considering a deal hasn’t been announced so far, it’s not a surprise the rupee has crossed 90 per dollar.
In such situations, people get carried away. But the truth is that there’s a lot of mean reversion. If you were to take the real effective exchange rate (REER) and plot it, you’ll see that it mean-reverts in a major way. And that is the beauty of why we call the currency a shock absorber or automatic stabiliser. For the last 20 years, if there is something that has not failed me, it is the mean reversion of the REER. It gives me the confidence that the currency never moves in one direction and it successfully plays the role of an automatic stabiliser.
Absolutely. If inflation was a bit elevated right now, everybody would be very worried about inflation and whether the RBI would be able to cut interest rates. But because inflation is very low, the RBI can still continue with rate cuts despite currency depreciation. So, low inflation is really giving us a lot of space. Even if currency depreciation adds to inflation — which it will, if it’s for a sustained period — my sense is inflation will remain below the RBI’s 4 per cent target not just in FY26, but I would argue even in FY27. This is because some of the drivers of disinflation this time around are quite structural and sticky.
GDP growth did come in at 8.2 per cent in July-September. But my sense is that there are several deflator issues which may have overstated it. My own back-of-the-envelope calculations to clean for these issues give me the sense that GDP growth was closer to about 7 per cent. On its own… it is a very strong number. By my calculations, India’s potential growth is 6.5 per cent; so, if you’re growing at 7 per cent, you’re actually doing very well.
But I must also add that we shouldn’t just be fixated on the growth number that we saw in July-September and also think about where it’s likely to go from here. My sense is that by the March quarter, we could start seeing growth soften for two reasons. One, the Goods and Services Tax (GST) rate cuts in the run-up to Diwali — that lovely period that we had where there was a lot of spending and retail sales — would peter out a little bit by March. Second, the government will have to tighten up its spending in the final quarter of this fiscal year because it’s got a fiscal deficit target to meet. And once it tightens up spending, then growth will start to look a little weak. From that perspective, I do think the RBI should be cutting the repo rate on Friday not just because inflation is very low and likely to remain so, but also because growth may need a helping hand down the line. And transmission of interest rate cuts takes time.
There are two paths to currency movements. One is through the economic fundamentals, which includes the balance of payments, the trade deficit, and inflows. The other is any RBI intervention that comes in the way. But it’s very difficult to ascribe a motive to intervention because the RBI’s policy is that it does not interfere with the direction of the rupee, but ensures its movement is smooth. How every governor defines smooth can vary from situation to situation. So, it’s very hard to compare two personalities because there are a lot of factors involved.
A big driver this time around are the economic fundamentals. The fact the trade deficit has widened and flows are weak are probably the main reasons why the rupee is going where it is.
What I did notice in the October trade number was, of course, gold imports being very high. That’s not because volumes are going up but the price of gold is increasing. And I think that will be in the (import) numbers for a while.
Then there are exports, which fell. Interestingly, in September, we saw exports to the US fall, but exports to other countries rise. But in October, exports to both the US and the rest of the world fell. I am watching this carefully. It’s possible that (was) because we had a lot of Diwali holidays in October and, therefore, data for November will be better. But, generally speaking, as long as there is a 50 per cent tariff on India’s exports, the data will be weak. All of this could keep the trade deficit wide for the next couple of months as well. From that perspective, the currency depreciating actually reflects those changing economic fundamentals.
