By Mihika Sharma
The Indian rupee closed at a record low of 83.67 against the dollar in the week ending July 19. However, year to date it has depreciated by only 0.5%, much lower than the depreciation seen in other Asian currencies like Chinese yuan (2.4%), Indonesian rupiah (5.2%), Thai baht (5.8%), Taiwanese dollar (6.8%), South Korean won (7.3%) and Japanese yen (11.7%).
During the week, factors such as a strong dollar, a weak yuan and dollar demand from importers weighed on the rupee. Whereas RBI interventions, FPI inflows and a narrow trade deficit offered some support.
The dollar ended stronger on account of safe haven demand amidst rising US – China tensions after Trump announced potential tariffs on Chinese imports ranging from 60% to 100%. However, market expectations that the Fed will begin rate cuts in September remained in place, as Fed Chair Powell noted that recent data added to some confidence that inflation is moving towards the Fed’s 2% target.
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The yuan weakened as China’s Q2 GDP growth fell short of expectations and markets were disappointed by the lack of major policy announcements at the Third Plenum to address China’s property sector crisis. Meanwhile, oil prices fell to a near one month low due to weak Chinese demand and growing hopes of a ceasefire in Gaza.
FPI inflows into India totalled USD 2.5 billion during the week, including USD 0.6 billion in debt. Separately, domestic data showed that merchandise trade deficit narrowed to USD 20.9 billion in June from USD 22.3 billion in May.
In the week ahead, the market focus will be on India’s FY25 Union Budget to be presented on July 23. The government is expected to prioritise the rural economy, job creation and welfare spending while maintaining its capital expenditure plans and fiscal prudence.
The FY25 fiscal deficit target is likely to be marginally reduced to 5% of GDP from 5.1% outlined in the interim budget, supported by RBI’s bumper dividend transfer of Rs 2.1 lakh crore and a marginal increase in tax collection.
Gross borrowings for FY25 are expected to be marginally lower around Rs 13.6-13.8 lakh crore, compared to the interim budget’s estimate of Rs 14.1 lakh crore. Net borrowing is likely to range between Rs 11.2-11.4 lakh crore, down from Rs 11.8 lakh crore outlined earlier.
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Overall, the budget is expected to have a neutral impact on the rupee. We expect the rupee to continue to trade between 83-83.80 in the near term, with a weak yuan maintaining pressure on the rupee, especially after the PBoC delivered surprise rate cuts on July 22.
Looking ahead, the rupee is expected to slightly appreciate, towards 82-82.50 level by the end of FY25, supported by India’s favourable fundamentals such as a manageable current account deficit and strong FPI inflows following inclusion in global bond indices. Any appreciation in USD/INR is likely to be limited as RBI aims to build forex reserves to contain rupee volatility.
The RBI is likely to begin rate cuts in H2 FY25, after the Fed, primarily due to concerns about high domestic food inflation. However, RBI’s rate cut cycle is likely to be shallow of about 50bps (25bps each in Q4 CY24 and Q1 CY25).
Besides the Union Budget, market focus will also be on developments related to the US Presidential elections, as well as the release of US Q2 GDP and PCE inflation data later this week. US GDP growth is expected to increase to 1.9% from 1.4% in Q1. Core PCE inflation, Fed’s preferred inflation gauge, is expected to marginally decline in June. Overall, market bets of a Fed rate cut in September are likely to remain intact, which should offer some support to the rupee going forward.
(About The Author: Mihika Sharma, Associate Economist at CareEdge Ratings)
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