the ongoing oil price war started by Saudi Arabia and Russia in early March, which has since seen Brent oil prices plunge from around USD 50 per barrel to below USD 30, will support a sharp improvement in India's terms of trade
Fitch Solutions on Tuesday revised down its forecast for the Indian rupee, saying the currency will average 77 per US dollar in 2020 and 80 in 2021 amid ongoing global risk-off sentiment and likely steep monetary easing. It saw real GDP growth at 5.4 per cent in 2020-21 fiscal that starts in April and 5.8 per cent in the following financial year.
“We at Fitch Solutions maintain our view for the Indian rupee to persist on a long-term weakening trajectory against the US dollar,” it said in a note. Over the short-term horizon, the ongoing global risk-off sentiment and likely steep monetary easing will pressure the rupee weaker, although this would be partially counteracted by a sharp improvement in India’s terms of trade due to the plunge in oil prices as a result of the ongoing oil price war.
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Over the long term, the rupee’s overvaluation and structurally higher inflation relative to the US would exert downside pressure on the currency. “We are, however, revising our forecast for the rupee to average INR77.00/USD in 2020 and INR80.00/USD in 2021, versus INR73.00/USD and INR75.00/USD previously,” it said.
The Indian rupee has depreciated by about 7 per cent since January and has averaged 72.10 to a US dollar in 2020. “The rupee’s weakness initially began with risk-off sentiment as a result of the central bank’s takeover of Yes Bank, which raised fears among investors regarding the banking sector’s stability. The drop has since been sustained by investor concerns around the growing Covid-19 pandemic, which is still causing a massive sell-off in global risk assets,” it said.
Fitch Solutions said Indian rupee being an emerging market currency with structural fundamental vulnerabilities such as its twin deficit (current account and fiscal account), make the currency susceptible to sell-off during periods of risk-offs.
“We believe that growing area lockdowns across the globe, with around 65 per cent of the global economy under some sort of lockdown or quarantine as of end-March, is likely to result in a global recession,” it said adding the ongoing risk-off is expected to have more room to run over the coming months.
Moreover, relative to Europe and Southeast Asia, the Covid-19 outbreak in India has just begun, and an increasing spread will weigh on the economic prints over the coming months. “Poor economic data will hurt investor confidence and result in rupee outflows,” it said.
Fitch Solutions said, while India’s number of Covid-19 cases has been grinding higher to about 400, the numbers are still suspiciously low given that India is the second-most populous country in the world.
“We think that this would raise concerns among investors regarding the government’s management of the crisis and as such, would also weigh on risk assets,” it said. Also, the Reserve Bank of India (RBI) is expected to implement steep monetary easing over the coming months.
This, Fitch Solutions said, is likely to feature a range of measures across its policy toolbox, which could include USD/INR swaps, long-term repurchase (repo) operations, interest rate cuts, reserve requirement adjustments and even changes to its interest rate corridor.
“We currently forecast 175 bps worth of cuts which would take the benchmark repo rate to 3.40 per cent by end-FY2020/21 (April–March), from 5.15 per cent at present,” it said adding this would significantly narrow the nominal yield differential with the US, thereby also putting weakening pressure on the rupee.
The RBI has also announced on March 18 that it would be injecting liquidity into the markets through the purchase of short-term notes and government bonds to ease bond yields which have spiked due to risk aversion.
However, the ongoing oil price war started by Saudi Arabia and Russia in early March, which has since seen Brent oil prices plunge from around USD 50 per barrel to below USD 30, will support a sharp improvement in India’s terms of trade over the near term given that the country imports 80 per cent of its total oil needs.
This will help limit the extent of rupee depreciation, the rating agency said, adding it has revised down its 2020 average Brent oil price forecast to USD 43.20 a barrel, from USD 62 previously. It forecasted inflation to average 3.1 per cent over FY2020/21 and FY2021/22 (assuming normal monsoon conditions).
Food and fuel prices tend to heavily impact inflation in India. Adverse weather during the growing season can easily lead to a surge in headline inflation due to poor crop yields even despite weak core inflation.
“While the ongoing oil price war would likely cause fuel deflation in India over several months, a sudden spike and consequent uptrend in oil prices due to an agreement at a later date between major oil producers would put upside pressure on inflation in India, especially with a weakened rupee,” it said.