Rupee Exchange Rate Hits Historic Low
On December 26th, the Indian rupee fell to a historic low of 85.497 against the US dollar, currently quoted at 85.283. This marks the third consecutive trading day that the rupee has set a new record. Since October this year, the rupee has depreciated 1.81% against the dollar, and it is expected to record its worst quarterly performance since the third quarter of 2022.
The prevailing market view attributes the rupee's depreciation to a strong dollar and end-of-year dollar demand from Indian importers. Financial institutions predict that the rupee-dollar exchange rate may fall below the 86 mark by March 2025, potentially weakening further to 86.5 by year-end.
Strong Dollar and Foreign Capital Withdrawal Pressure
Due to hawkish signals from the Federal Reserve, the dollar continues to strengthen, and traders expect the dollar to remain robust through the first quarter of 2025. Additionally, the continued withdrawal of foreign capital from the Indian market has exacerbated rupee depreciation pressures. Data shows that on December 26th, global funds had a net sell-off of Indian equities amounting to 18 billion rupees, with a cumulative net sell-off of Indian stocks and bonds reaching 10.3 billion dollars for the fourth quarter.
Morningstar Investment Research's India Division pointed out that high valuations and geopolitical uncertainties are the main reasons for foreign capital withdrawal. Meanwhile, India's trade deficit expanded by 18.4% year-on-year from April to November, further dragging down the rupee's performance.
Slowing Economic Growth Exacerbates Policy Uncertainty
India's economic growth rate continues to slow. In the third quarter of 2023, India's real GDP grew by 5.4% year-on-year, down from 6.7% in the previous quarter, marking the lowest level since the fourth quarter of 2022. This growth rate was below the expectations of the Reserve Bank of India and the market. As a result, the Reserve Bank of India has revised its annual GDP growth forecast down from 7.2% to 6.6%.
Goldman Sachs predicts India's GDP growth will drop to 6.3% in 2025, citing fiscal consolidation and slower credit growth as reasons. Additionally, uncertainties across multiple economies and aggressive policies may threaten domestic growth in India.
Central Bank Intervention and Policy Direction
The depreciation of the rupee has prompted the Reserve Bank of India to intensify foreign exchange interventions. Since October, the Reserve Bank of India has net sold 9.28 billion dollars in an attempt to stabilize the exchange rate, but has not effectively stopped the depreciation trend. Nevertheless, the rupee's real effective exchange rate reached a high of 108.14 in November, indicating the rupee is still overvalued, making a substantial rebound unlikely in the future.
There is considerable uncertainty around the policy outlook of the Reserve Bank of India. On December 9th, the Indian government appointed Sanjay Malhotra as the new governor of the central bank, known for his dovish stance on monetary policy. Market forecasts suggest he may push for a rate cut at the monetary policy meeting in February 2024. However, the impending departure of Deputy Governor Patra has added more uncertainty to the decision-making of the monetary policy committee.
Outlook Analysis
The continued depreciation of the Indian rupee and slowing economic growth present a dilemma for the Reserve Bank of India's monetary policy. Analysts believe the Reserve Bank of India may continue its interventions in the foreign exchange market to stabilize the exchange rate, but the effectiveness of these policies is constrained by the strong dollar and the withdrawal of foreign capital. The future trajectory of India's monetary policy and its impact on the economy remain areas that require ongoing attention.
