India's Currency Is Under Pressure — and Analysts Say the Rupee Could Test New Lows

• The Indian rupee has come under intense selling pressure in recent weeks due to a perfect storm of global headwinds which analysts say will continue to pummel the currency in the months ahead.
• It has already tested record lows falling more than 80 to the dollar level twice in July, only recovering after the Reserve Bank of India stepped in to stem the slide.
• Finance Minister Nirmala Sitharaman attributed the rupee's depreciation to external reasons, in a written statement to parliament recently.

The Indian rupee has come under intense selling pressure due to a perfect storm of global headwinds which analysts say will continue to pummel the currency in the months ahead.

In recent weeks, the Indian currency tested record lows and breached the 80 rupees per U.S. dollar level at least twice in July, recovering only after the Reserve Bank of India (RBI) stepped in to stem the slide.

The currency has since regained some ground and was around 79.06 to the dollar on Thursday.

The recent sharp declines prompted a swift response from policymakers to assuage concerns about a rupee sell-off, which could drive prices even lower.

Finance Minister Nirmala Sitharaman attributed the rupee's depreciation to external reasons, in a written statement to parliament in late July.  

Global factors such as the ongoing Russia-Ukraine war, soaring crude oil prices and tightening of global financial conditions are among the key reasons for the weakening of the Indian rupee against the dollar, she said. 

Analysts agreed the currency is being buffeted from multiple fronts globally.

Soaring energy prices

India's exposure to high energy prices has had knock-on effects on the currency, with the rupee falling more than 5% against the dollar year-to-date.

Soaring energy prices are especially challenging for India — the world's third largest oil importer — which typically buys oil in dollars. When the rupee weakens, its oil purchases become more expensive. 

According to Nomura analysts, for every $1 increase in the price of oil, India's import bill increases by $2.1 billion.

There's been a "significant uptick" in Russian oil deliveries bound for India since March after Russia's invasion of Ukraine began — and New Delhi looks set to buy even more cheap oil from Moscow, industry observers say.

Early data from June showed India's supply of Russian crude reached nearly 1 million barrels per day, up from 800,000 barrels per day in May, according to investment advisory firm Again Capital. 

"Usually, weaker currency acts as a pressure valve to restore external stability by making exports more competitive and reducing demand for imports by making them more expensive," said Adarsh Sinha, co-head for Asia-Pacific forex and rates strategy at the Bank of America Securities.

"Oil imports from Russia, if settled in rupee, would reduce dollar demand from oil importers. These rupees could be used to settle payment for Indian exports, and/ or invested into India – both could be beneficial," he told CNBC.

In July, India's central bank put in place a mechanism for international trade settlements in Indian rupees. The measure allows traders to bill, pay and settle imports and exports using the Indian rupee, which will help a long-term goal to internationalize the Indian currency, analysts said.

"This move is constructive for the rupee in the medium-term as higher INR [Indian rupees] demand for settlements implies lower demand for forex for current account transactions," Radhika Rao, senior vice president and economist at DBS bank, said in a recent note.

This will facilitate "trade with neighboring countries, with trading partners who are unable to access dollar funds and/are temporarily outside the international trading mechanism and those looking to broaden their pool of trade settlement currencies," she wrote.

Remittances remain resilient

While a weak rupee puts pressure on India's imports from other countries, it may help boost the country's remittances from abroad.

Remittance flows to India grew by 8% to $89.4 billion in 2021, based on recovery in the United States, which accounts for a fifth of the country's remittances, according to World Bank data.

"Remittances could be determined by many factors but [a] weaker rupee helps increase domestic value of those remittances which would help offset inflationary pressures for the recipients," said Sinha from BofA Securities.

Goldman Sachs also said in a recent note remittances to India "should remain resilient on the back of stable economic growth in the Middle East, benefiting from higher oil prices."

Deficit problems

Still, India's widening current account deficit is expected to remain a continuing drag for the rupee, exacerbated by ongoing large capital outflows, analysts warned.

"India's external balances are deteriorating, driven by a terms-of-trade shock from elevated commodity prices, which is resulting in wider current account deficits," said Santanu Sengupta, India economist at Goldman Sachs.

A current account deficit occurs when a country's imports exceed its exports.

In a market environment that is not conducive for emerging market portfolio inflows, "we estimate a large balance of payments deficit. This has meant continued FX reserves drawdown across spot and forward books held by the RBI," he added.

According to Nomura's recent note, Indian equities have already experienced $28.9 billion of net foreign outflows year-to-date in July, the second most among Asian economies, excluding Japan. 

But India's large external buffers have "have provided confidence in RBI's ability to prevent tail risk scenarios from spilling over to domestic interest rates and impacting growth further when it is already going through a rough patch due to higher commodity prices and supply disruptions, along with tighter monetary policy," said Sinha.

"Our projection of balance of payment deficit indicates a shortfall of USD 30-50bn this year. RBI has adequate reserves to sustain intervention for at least another year," he added.

In an attempt to defend the rupee, the central bank announced a slew of measures recently aimed at encouraging capital inflows. The measures include easing regulations on foreign deposits, relaxing norms for foreign investment flows into the debt market and for external commercial borrowing.

'Taper tantrum'

Despite the rupee's current underperformance, the currency's fall is still more contained today compared to the "taper tantrum" in 2013, analysts said, citing better fundamentals this time round.

At that time, the Federal Reserve's decision to scale back its extraordinary monetary stimulus triggered a sell-off in bonds, which caused Treasury yields to surge and the U.S. dollar to strengthen. That led to an exodus of funds out of emerging markets.

"Much of [the Indian rupee's] depreciation pressure stems from sharp gains in the US dollar as the latter benefits from wide rate and policy differentials," said DBS's Rao in a recent note, explaining the high interest rate difference between the greenback and rupee as interest rates in the U.S. continue to rise.

The pressure to defend the rupee's depreciation is not as high as back during the taper tantrum, she added. If pressures do intensify, the government has options such as deferring purchases of bulky defense items that would help to reduce the dollar demand, she wrote.

Analysts also argued India's external balances, which is often cited as a source of vulnerability, has some inbuilt buffer against further rupee depreciation risks.

"Until now, even in the face of deteriorating external balances, the stock of FX reserves were limiting India's external sector vulnerability, and have allowed for a slow depreciation of the INR (vs. the USD)," said Sengupta from Goldman Sachs.

"Going forward, as FX reserves get depleted, and real rate differentials shrink, India's external vulnerability risks will increase — though they will likely compare better than the 'taper tantrum.'"

Can rupee drop to 82 per dollar?

As global conditions continue to remain in flux, the rupee will face further downside risks in the coming months, analysts said.

"With global capital flows drying up in a Fed tightening cycle, US recession risks coming to the fore, and India's external balances becoming challenging, we are likely to see continued weakness in the INR going forward," said Goldman Sachs' Sengupta.

As a result, the bank forecasts the Indian currency could be around 80-81 rupees per dollar over the next 3 to 6 months, "with risks tilted towards even further weakness in the event of more acute dollar strength," he added.

Other analysts even expect the rupee to test fresh new lows in the near term.

Craig Chan, Nomura's head of global FX strategy, said he does not believe the level "80 is sacrosanct."

"We do not believe there is any particular market positioning factor that should lead to an accelerated move higher in USD/INR if 80 breaks – unlike in 2013," he added, referring to the "taper tantrum" period. "Our last call was INR [rupee] risks breaking the 80 to dollar level and overshoots to 82 by the end of August."

Sinha from BofA Securities also expects the Indian currency to reach the 82 level by end-2022 due to continued volatility in the global environment.

"However, we see tails risks of larger depreciation contained by RBI's ample reserves buffer," he said.