The Indian rupee is under pressure — that may signal economic trouble ahead

Key Points
  • The Indian rupee, which hit its lowest in 15 months against the U.S. dollar on Monday, is expected to depreciate even more, analysts said.
  • The weakened currency signals potential troubles that await Asia's third-largest economy amid higher oil prices and rising interest rates in the U.S., analysts said.
  • India's current account and fiscal deficits mean the central bank may have little room to tap into its reserves to to defend the currency.

India entered 2018 with the resolve to turn around its economy, but signs of stress have shown up in one barometer: the currency.

The , which strengthened 6.75 percent against the U.S. dollar last year, has been on a general downtrend since the start of 2018. The currency on Monday hit its lowest in 15 months to trade at 67.13 rupees against a dollar — that's a 5.15 percent fall for the year so far.

And the currency is expected to weaken further, according to analysts including those from Australian bank ANZ and Dutch lender ING.

An employee counts Indian currency notes at a cash counter inside a bank in Kolkata.
Rupak De Chowdhuri | Reuters

"We believe its troubles are far from over, as several external and internal factors will continue to expose it to considerable weakness in 2018 and beyond," Prakash Sakpal, Asia economist at ING, wrote in an April note.

The rupee coming under pressure signals potential troubles that await Asia's third-largest economy, which saw growth slowed in the past year as it grappled with a surprise demonetization, the introduction of a Goods and Services Tax and mounting bad debt in the banking sector.

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Those problems have taken a back seat, but the recent rise in oil prices now threatens to widen the country's deficits at a time when government spending has increased.

India is a net importer of oil and every $10 per barrel increase in price could worsen its current account and fiscal balances by 0.4 percent and 0.1 percent of GDP, respectively, Nomura analysts estimated. That could shave around 15 basis points off the country's growth, the analysts wrote in a note.

Rupee is no longer in that sweet spot
Maybank analysts

A weaker rupee and higher oil prices will cause inflation to accelerate, which may prompt the Reserve Bank of India to hike interest rates earlier than expected, the analysts said. Higher domestic rates, coming before the economy has found a stable footing, could also derail India's recovery.

Defending the rupee

With interest rates in the U.S. set to rise further, India — one of the biggest victims during the "taper tantrum" in 2013 — has once again found itself defending against large amounts of capital outflow. That's placing additional pressure on the rupee.

The government has relaxed requirements on foreign investments in its capital markets, but the selloff has continued, according to data by the country's National Securities Depository Limited. India saw a net outflow of $244.44 million by the end of April this year, reversing the $30.78 billion of net buying for 2017, according to the data.

India has over the last year built up its foreign reserves, but its financing needs — a result of its twin deficits — mean the central bank may not have much room to intervene should the selloff worsen, said Radhika Rao, an economist at DBS.

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But not all is lost for the rupee and India's economy, according to analysts at Malaysian lender Maybank. The RBI said economic activity could accelerate given signs of rising capital expenditure and improving global demand, which would help the currency to stabilize, they noted.

"Rupee is no longer in that sweet spot," the analysts wrote last week.

"Having said that, we are cautiously optimistic that rupee could find a foothold eventually when rates and oil stabilize and a sustained global growth could eventually narrow the (current account deficit), boost income and anchor the (rupee)," they added.