Worse Yet To Come For Rupee Already Reeling Near Historic Lows

The worst is still to come for the Indian rupee after its slide in May to a historic low, according to analysts and forward markets.

The currency may drop to between 79 to 81 per dollar over the next few months, according to analysts from UBS AG to Nomura Holdings Inc. and Bloomberg Economics. Forwards are also pricing in a similar weakness for the rupee.

The bearish forecasts -- which will see the rupee drop as much as 4% from current level -- stem from a deterioration in India's external finances. Higher oil prices threaten to widen the current-account deficit to at least 3% of the gross domestic product, compared to a 2% sustainable level, according to UBS, even as outflows from its equity markets accelerate.

“A grind higher for USD/INR from here toward 80 in the next couple of months is not a big ask,” said Rohit Arora, emerging markets Asia strategist at UBS. “Nor do I think 80 is a runaway depreciation by any metric. It's a very modest adjustment of a currency with deteriorating fundamentals.”

The rupee declined about 1.6% in May, the biggest drop among emerging Asian currencies, spurring Reserve Bank of India Governor Shaktikanta Das to say that the central bank won't allow a runaway depreciation of the currency. The current account deficit can still be comfortably funded this year, he added.

The central bank has foreign exchange reserves of nearly $600 billion and has been using this pile to smooth out any volatility. Rupee traders will look forward to its monetary policy review on Wednesday, where it's expected to raise interest rates after an out-of-policy hike in May.

Bloomberg Economics predicts the rupee will fall to 81 a dollar by the end of November. Nomura Holdings Inc. sees the currency at 79 by end June, while Standard Chartered Plc also sees a similar level by the third quarter. The currency closed at 77.6325 on Friday.

The debate around how much depreciation the RBI will allow is also linked to the currency's use as a policy tool. Some argue that the central bank won't tolerate a weak rupee when inflation has become its primary focus. Another argument is the rupee still remains over-valued in trade-weighted terms and some decline isn't necessarily bad.

“We have been a little more bearish than consensus because we think the underlying balance of payments dynamics have deteriorated quite significantly,” said Divya Devesh, head of ASEAN and South-Asia FX research at Standard Chartered in Singapore.

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