A number of factors such as the unusual combination of a stronger USD and high crude oil prices, India's widening twin deficit, and foreign institutional investor (FIIs) outflows have contributed to the recent around 5 percent weakening of the rupee against the USD.
However, the rupee remains strong in real terms against the USD and also against the basket of six major trading partners' currencies.
Our analysis of the long-term INR trends suggests that the movement in the USD index (trade-weighted against major currencies) is the most important determinant of the INR movement, followed by the movement in India's foreign exchange reserves (or balance of payments, BoP) and India's twin deficit (sum of fiscal deficit (FD) and current account deficit (CAD)).
Higher crude oil price, however, does not necessarily imply a weaker INR unless it is accompanied by capital outflows (or weaker BoP).
Although we do not expect any rally in the USD in 2018 and 2019, India's BoP (sum of the current and capital/financial account) is likely to witness its first deficit in seven years in FY19 versus massive surplus of $43.6 billion in FY18.
Further, real GDP growth is likely to remain at sub-7 percent for the second consecutive year and the twin deficit is expected to stay at elevated levels of 8.2 percent of GDP in FY19.
Finally, along with the general election in May 2019, five major states are scheduled for assembly elections between end-2018 and mid-2019.
All the above-mentioned factors are likely to keep the INR under severe pressure.
Accordingly, we expect the INR to touch 70 against the USD by first half of CY19 and average 68.2 in FY19 and 70.9 in FY20.
Two uncertainties, however, could move the INR either side - (1) if the incumbent BJP government registers another grand win in the general elections - putting political uncertainty behind - capital inflows will improve India's BoP and the INR could appreciate. (2) On the contrary, a stronger USD - say because of weakening in the non-US developed world - could make the INR touch 70 sooner than expected.
Source: moneycontrol.com