If there’s one currency that underscores the distortions playing out in global markets in 2016, it’s the Indian rupee.
India’s status as a net oil importer prompted Goldman Sachs Group and HSBC Holdings to predict a rally in its currency as the rout in crude prices intensified at the end of 2014. Instead, the rupee has been dragged lower as investors flee emerging markets, posting a fifth straight annual drop in 2015 and falling the most in Asia this year.
The rupee’s slide belies bright spots in the third-largest Asian economy. Cheaper oil has narrowed India’s current-account deficit from a record-high in 2013, and the pace of economic growth has overtaken China’s. Yet right now, these factors aren’t counting for very much, with options traders gearing up for more rupee losses.
“If the drop in oil prices and the lower current-account deficit had occurred against a more settled global environment, I would have expected a clear rupee outperformance,” said Sean Callow, a foreign-exchange strategist in Sydney at Westpac Banking Corp. “In periods of pronounced risk aversion, we do see investors selling winners as well as losers.”
Callow sees the rupee weakening to 69.5 per dollar by year- end, breaching a record-low of 68.845 set in 2013. The currency dropped 0.7%, the most in a month, to close at 68.30 a dollar in Mumbai on Thursday.
Like Goldman Sachs and HSBC, Westpac failed to anticipate the rupee’s decline, and at the end of 2014 predicted a 6% rally for last year. The currency went on to drop 4.7% in 2015 and has already fallen a further 3.1% this year.
The rupee is a casualty of the broader selloff in emerging markets that’s coinciding with fading confidence in Prime Minister Narendra Modi’s ability to push through economic changes including a goods-and-services tax that’s currently deadlocked in parliament.
Global funds pulled a net $1.7bn from Indian stocks in January, the biggest outflow in five months and part of an investor exodus that’s wiped about $7.9tn from global equities this year.
The premium for options to sell the rupee in three months over contracts to buy has widened to 2.3 percentage points, the most since September and up from 1.3 percentage points at the end of last year, data compiled by Bloomberg show.
The weaker currency, and Brent crude’s drop to a 12-year low, are bringing some benefits to the economy. The exchange rate makes the clothing, cars and pharmaceuticals India sells overseas more competitive.
The current-account deficit narrowed to a seven-year low of $27.5bn in the year ended March 2015, down from a record $88bn two years earlier.
HSBC remains cautiously optimistic on the rupee. David Bloom, global head of foreign-exchange strategy, says that while the Indian currency is falling against the dollar, it has performed better than many of its emerging-market peers since the bank made its call in December 2014.
Cheaper oil is still a positive, he says, and the currency is a victim of the broader rout in emerging assets. Bloom sees the rupee remaining steady in 2016 and ending the year at 69 per dollar.
“It’s got three good things going for it,” Bloom said. “The oil price falling is very good for it, people have a belief in India because of the political system and people are desperate for an alternative to China.”
Investors will be watching the annual budget on February 29 for signs of progress in Modi’s economic agenda.
With many of the changes still pending, the rupee could go either way, according to Viraj Patel, a London-based strategist at ING Bank. He says the currency would suffer if Modi’s programme were blocked, though a recovery in global markets could spark a rebound, and predicts a decline to 68.5 per dollar by mid-year.
India’s “positive fundamental backdrop is being overshadowed by the weakness in global risk sentiment, and when the volatility subsides, the currency will drift back to its more medium-term equilibrium, and that right now we think is closer to 67 to 67.5,” said Patel.
“Fiscal sustainability plays a key role in any currency value, and any uncertainty on this front will be reflected via a weaker currency.”