The Indian rupee's recent depreciation, which saw it breach the psychologically significant 90-mark against the US dollar, is primarily a cycle of weakness driven by capital flows rather than fundamental domestic economic weaknesses, according to a leading economist.
A Different Kind of Rupee Weakness
In an exclusive interview, Rahul Bajoria, Head of India and ASEAN Economic Research at BofA Global Research, highlighted a key distinction in the current phase of rupee depreciation. Unlike previous episodes such as the 'taper tantrum' or the 2018 currency pressure, the current slide is not accompanied by a widening current account deficit (CAD).
"What we are seeing in India now is essentially a capital flows-driven weakness cycle," Bajoria stated. He attributed this to external factors including anxiety over domestic growth prospects and the impact of the unfinished trade deal, among other global headwinds.
Inflation and Macro Impact: Limited Concerns
A significant silver lining in this episode is the subdued inflationary environment. Bajoria pointed out that while currency depreciation inevitably adds some inflationary pressure, inflation is not a very big concern within the system now. This situation lowers the risk of second-order negative shocks that typically accompany a currency move of this magnitude.
On the macroeconomic front, the economist views the rupee's movement as a shock absorber. He noted that the rupee has weakened by about 6.5% over the past year, making it weaker relative to other regional currencies. However, from a spot standpoint, he does not consider this level debilitating for the economy.
He further explained that India's largest sources of imported inflation, like crude oil, have seen prices decline more than the rupee this year, cushioning the impact on overall import costs.
RBI's Policy Stance and the Path Ahead
Bajoria observed a shift in the Reserve Bank of India's (RBI) intervention strategy. "The way the RBI has managed this cycle, it feels like the central bank is no longer intervening with the kind of intensity that they probably were earlier," he said. This appears to be a policy choice to let the rupee relieve some built-up pressure, allowing automatic stabilizers to work.
Looking forward, he expects the rupee to remain under pressure for the next few weeks. With the key 90-level breached, the pressure on the RBI to defend a specific threshold has diminished, giving the central bank more degrees of freedom in managing the currency.
The ultimate resolution, according to Bajoria, hinges on the return of external capital flows. "This is ultimately a function of capital flows — if that comes back and when do they come back, which will be the biggest delta difference," he concluded. Factors like progress on a trade deal could swiftly improve sentiment, while its absence would keep confidence fragile.
Despite the volatility, the underlying economic conditions related to CAD, fiscal management, and inflation do not point to a systemic loss of confidence that would lead to a material devaluation from current levels, the BofA economist affirmed.
