Top 5 reasons why Rupee is on a tricky road ahead; could well hit Rs 70/USD soon

Rising oil prices, political risk in a pre-election year, low equity risk premia pointing towards relative high valuation and tightening financial conditions in the domestic economy are major factors specifically hurting the Rupee

The Rupee has had a rough 2018, which is not surprising as a number of factors are stacked against the currency. INR has weakened three-fourths of its major emerging market (EM) peers.

Rising oil prices, political risk in a pre-election year, low equity risk premia pointing towards relative high valuation and tightening financial conditions in the domestic economy are the major factors specifically hurting the Rupee.

Strong US economy is prompting the US Fed to tighten monetary policy and trade war are affecting more or less all emerging markets and hence not a Rupee-specific risk.

As a result, carry trade which is the biggest force that drives currency markets, especially EM currencies, is on reverse gear for Rupee in 2018.

Unlike last year, inflows in the bond market have turned negative, with $6.2 billion in the June quarter. FX traders who used to bet on Rupee appreciation last year by taking short positions in the USDINR forwards and futures are sitting on the sidelines.

Here is the summary of the factors driving the Rupee:

Trade war & Chinese Yuan

A trade war is an election issue in America, as they head to mid-term polls in November 2018. Trump is determined to win the elections for Republicans and retain a majority in Senate and House.

He believes that spending, tax cuts, trade and emigration are issues which can get his party the winning votes. China is caught right in the middle of the trade fiasco, which is causing capital flight.

As a result, Chinese Yuan is spiralling lower and that is bad news for Rupee too, as weaker Yuan, in parity terms drags down INR too.

Higher oil prices

Iran sanctions are driving oil prices higher. Higher oil is bad news for India too. As a heuristic a $10/barrel average increase in oil prices can add 10 bps to India’s fiscal deficit through higher fuel subsidy.

Additionally, if the government reduces excise duty on petroleum products to reduce the burden on the citizens, then the exchequer takes an additional hit of around Rs 10,000 crore, which is around 6 bps of increase GFD.

Additionally, rising oil prices feed into consumer inflation through direct and indirect channels. As a rule of thumb, it can be said that a $10/barrel average increase in oil prices can increase CPI by around 40-50 bps.

Higher inflation is not only a drag on household consumption but also raises the possibility for RBI to tighten its monetary policy.

Strong US economy & Fed

With US economy enjoying strong economic momentum and US government very much committed to use the fiscal levers to keep it that way, wage inflation has begun to rise.

This emboldens Fed and they can continue to hike rates and lower reserves in the system. That is also bad news for EM currency like Rupee.

Domestic political risk in a pre-election year

This is not going to go away soon, as elections are still a year out.

Financial conditions are tightening in the domestic economy

The Reserve Bank of India (RBI) has begun the rate hike cycle, which is a headwind for domestic equity markets and bond markets. It discourages inflows and can cause Rupee to weaken.

Going forward, it is expected to be a challenging year for the Rupee, as most of the above factors are not expected to change much.

Oil prices remain the joker in the pack. As long as oil prices do not come down, we can expect INR to depreciate further against USD and can even test the level of 70 during the course of the year.

Disclaimer:-The views and investment tips expressed by investment experts are their own. Ripples Advisory advises users to check with certified experts before taking any investment decisions.

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