August saw a minor decline in the value of the Indian rupee of 0.3% versus the US dollar, with August 12 marking a new record low of 83.98. In comparison, during the same period, the majority of other Asian currencies have appreciated in value relative to the US dollar. Notably, thus far this month, the Chinese yuan has strengthened by 0.6%, the Japanese yen by 1.9%, the Indonesian rupiah by 1.9%, and the Malaysian ringgit by 3%.
The unwinding of global carry trades is a major factor contributing to the rupee’s fall. In these trades, investors fund long positions in the rupee with low-yielding currencies like the Chinese yuan and Japanese yen.
But when the Bank of Japan (BoJ) surprised everyone by raising its policy rate in July and delivering a hawkish stance, investors began to pull out of carry trades. A decline also aided the unwinding of carry trades in the dollar index, which was sparked by poor US labor market statistics.
Unexpectedly, the US unemployment rate rose from 4.1% in June to a three-year high of 4.3% in July, sparking fears of a recession and forcing markets to factor in more aggressive Fed rate cuts. Markets are now pricing in a total of 100bps of Fed rate reduction in 2024, up from the previously anticipated 50bps. As a result, the likelihood of a 50bps rate cut by the Fed in September increased to 100%.
Nevertheless, the Reserve Bank of India’s (RBI) actions restrained the rupee’s decline and controlled volatility. The RBI’s decision to maintain the policy rate at a high level also prevented the rupee from depreciating too much.
US consumer price index (CPI) data will be widely monitored in the upcoming week. Given recent remarks from US Fed officials suggesting a rate drop as early as September, and with inflation likely to approach the Fed’s 2% target, this should maintain market expectations of Fed rate cuts and should offer some support to the rupee.
In addition to causing portfolio withdrawals from overseas investors, the continuous volatility in international markets is also straining the rupee. August saw FPI withdrawals of USD 1.7 billion from Indian equities (as of August 12). However, thanks to India’s inclusion in the bond index, the debt segment has seen net foreign portfolio inflows of about USD 852 million over the same time period.
In the near future, we anticipate that the rupee will trade between 83.60 and 84.10. A slowing in the unwinding of carry trades and a reduction in concerns about the US recession could help it, but rising oil prices could be a problem.
