What’s Causing the Slide?
The INR has been sinking to record lows in recent weeks, despite intermittent intervention by the Reserve Bank of India (RBI), and it breached INR 79 against the USD on July 5. The FII exodus, a widening current account deficit (as crude prices remain elevated) and global monetary tightening have contributed to the 6% slide in the currency since the start of 2022.
Figure 1: INR/USD (average)
Capital outflows have continued for six consecutive months; about $30.6bn worth of FII outflow has been recorded so far in 2022 (through early July). Foreign institutional investors withdrew about $6.6bn from Indian capital markets in June alone. The persistent withdrawals are mostly a reflection of rising inflation (which stood at 7% y/y in May), global monetary tightening and higher yields elsewhere, and the potential impact of a global slowdown on the domestic economy. Additionally, some global portfolio managers have been switching equity funds back into China based on relative valuations. India appears to be the worst hit among its major emerging market peers with respect to FII outflows.
Figure 2: Foreign Portfolio Investment Net Investment 2022
Source: National Securities Depository Ltd., India. **-data up to July 12
Additionally, tepid exports against the background of a sharply rising import bill in June, leading to yet another record high trade deficit of $25.6bn, have contributed to currency weakening as well. Although exports continued to trend upward and grew 16.7% y/y in June, India’s import bill ballooned to $63.5bn during the month, representing 51% y/y growth.
Figure 3: Exports, Imports and Current Account Deficit ($m)
Given subdued global demand amid a rising import bill, we expect the trade deficit to continue to widen, and concomitantly the concerns around the weakening INR are now heightened. India’s foreign exchange reserves fell 2% m/m in May, as the RBI continued to intervene in the FX market. Although at $588.3bn foreign reserves provide over nine months of import cover, this is less than the 12 months accounted for earlier in January. The RBI amended norms earlier in July in a bid to boost foreign exchange inflows amid the continued currency slide. The measures included an easing of foreign investment in the debt market and increasing borrowing from foreign sources. However, our take on these measures is that they are unlikely to yield any strong favorable results given global monetary tightening. Our expectation is that the INR will see additional volatility in the coming months and fall to below INR80:$1 before stabilizing toward the final quarter of 2023. Our broader USD view is for slow Fed tightening in the autumn, then stopping in November and a pickup in 2023 rate cut expectations, which should ensure that the current high USD partially reverses against the majors and INR (here).