India is experiencing macroeconomic conditions that are truly unprecedented. It shines as a

beacon of hope in a slowing global economy. According to the IMF , India will contribute 17% of global

growth in CY 2024. Increased tax receipts driven by economy formalization and strategic reductions

in revenue expenditure (e.g., subsidies) has led to a period of fiscal consolidation. This has enabled

retail inflation to fall to ~3.5%. Further, India’s balance of payments continue to improve on the back

of higher services exports, foreign flows and remittances, coupled with lower commodity prices.

What implications, if any, will these positive macroeconomic developments have on the Indian

rupee?

Over the last 20 years, the Indian currency has held a steady depreciation rate of ~3% on an

annual basis. However, upon a closer examination of the INR/USD price chart, it becomes evident

that the rupee moved downward sharply (10%+ decline) against the dollar in three concentrated

periods; with a more sanguine depreciation of 1-2% annually in other times. In 2012-2013, severe

weakness in the Indian economy on the back of high inflation and policy paralysis led to a declining

rupee relative to all major currencies. It was exacerbated by the effects of the Fed’s move to reduce

its QE program, popularly coined the ‘taper tantrum. ’ In 2017-2018, the culprits were spiking oil

prices, US-China trade tensions and a widening current account deficit driven by economic

weakness from Demonetization and the newly introduced GST. Third, in 2022 the Fed sharply hiked

rates (425bps) in an attempt to battle COVID-induced inflation – causing the rupee to significantly

decline as FPIs fled Indian markets to chase higher yielding treasuries.

However, 2022 was different (relative to 2013 and 2018) wherein the Indian currency was

either stable or outperforming other major currencies like the British pound, euro and Japanese yen.

Therefore, the decline was largely a function of a strengthening U.S. dollar: with the Dollar index (DXY)

going from ~95 to a peak of ~113. This increase suggests that the Indian currency should have

depreciated more than ~10%. Further, the rupee was roughly flat (down ~0.8%) in 2023 when the Fed

continued to hike (an additional 100bps). While the RBI cushioned the decline by selling down their

dollar reserves (which reduced by ~$70bn in 2022), it mainly showed the tremendous resilience of

India’s economy. Careful management of government finances during COVID, a robust recovery and

strong capital account inflows (FDI + FII) contributed to this.

Going forward, we may be entering into a ‘golden period’ for the rupee. Markets have priced

in a 25bps reduction in the Fed Funds Rate in September with another ~100bps of cuts over the next

2 years – as evidenced by the 2-year Treasury yield. It will be interesting to see whether the RBI

initiates its own rate reduction cycle (per market expectations in December) on the back of positive

inflation data. However, the RBI will have to consider a rate cut’s negative impact on banking

deposits, that have been growing slowly relative to credit growth. In any case, the interest rate

differential between the Fed Funds and RBI Repo Rate will be positive for the rupee. However, it is

important to note that this story is somewhat complicated by potential global recessionary fears

(~35% probability according to JPM) which could cause foreign investors to look for safer havens.

On the whole, demand for the rupee will remain strong as India grows in importance as a key

investment destination for foreign portfolios. Further, the RBI’s Forex reserves (now $680bn+) offer

an important buffer to the currency. These factors have begun presenting themselves in INR/USD

currency markets with record low FX volatility translating into decade-low hedging costs.