RBI to maintain pragmatic approach, USD/INR likely to trade at 69 by end-2016

The Reserve Bank of India intentionally maintained a tight monetary policy in 2014 to curb inflationary expectations even at the expense of economic growth. As inflation eased, it gave the path for the Indian central bank to begin lowering the interest rate in 2015. Last year, the Reserve Bank of India cut rates by a total of 125 basis points to 6.75 percent. As inflation started to weaken and as growth languished the RBI cut the interest rate by additional 25bps to 6.5 percent in April this year.

“We continue to look for a further 25-75bp cut this year”, said Commerzbank in a research note.

But the reduction in rate would be dependent on stable financial markets and inflation. The restriction might come from the central bank’s desire to keep a real interest rate of about 1.5 percent to 2 percent. Given that inflation might be seen at about 5 percent in the coming year, it might suggest a policy rate of about 6.5 percent to 7 percent. As such it is already at the lower end of this range unless the RBI is ready to compromise with an even lower interest rate range.

Meanwhile, it is unlikely that there would be a major sell-off in INR. The Indian rupee and the Indonesian rupiah were the two worst performing Asian currencies at the height of the Fed Taper Tantrum in 2013. USD/INR had surged almost 30 percent to just below 70 on the twin deficit concerns, that is fiscal and current account deficits, stated Commerzbank. However, since then, both the deficits have declined, mainly due to a sharp decline in oil prices.

Last year, the currency pair was quite stable because of the improvement in economic fundamentals. For example, the INR depreciated by about 5 percent against the US dollar in 2015 vs the average drop for Asian currencies of 8 percent. It has lagged behind other currencies in Asia so far in 2016, said Commerzbank. The rupee’s attractive yield and enhanced fundamentals might continue to give an attractive proposition for investors seeking for yield.

“We expect RBI to maintain a pragmatic approach in 2016 and aim to reduce excessive volatility rather than target a particular level, we see USD/INR at 69 by end- 2016”, added Commerzbank.