Indian policymakers unfazed by rupee’s depreciation

Since the beginning of 2016, the Indian rupee, like many major EM currencies, has declined significantly against the US dollar. However, there is little reason for the central bank policymakers to panic. Firstly, the recent decline in rupee has happened in an orderly and gradual manner. Moreover, the rupee continues to be a relative outperformer in a longer time horizon. The rupee, since the beginning of 2015, depreciated 7.5% against the US dollar, as compared with much larger declines in other EM currencies.

The sharp narrowing of India's current account deficit has been important in reducing the nation's gross external financing requirement. Moreover, the rupee is much less vulnerable to sharp sell-offs due to an increase in FX reserves. Hence, even if the US Fed tightens its policy more rapidly than markets expect currently, the rupee will depreciate only gradually in the coming years.

Meanwhile, in the recent weeks, yields on the country's local currency debt has increased as projections for further reductions in local interest rates have been scaled back after the continued acceleration of inflation. Since the beginning of 2016, net foreign purchases of Indian debt have become negative.

Meanwhile, interest rate swaps have also been rising in the last few weeks as investors have lowered their projection for the central bank to further reduce interest rates. On equities, the benchmark Sensex stock index fell by nearly 10% in 2016. EM equities have generally performed poorly in recent times, implying the global factors at play.