USDINR may scale 86 soon as RBI may shift stance and election looms

Summary

RBI has to lower borrowing costs of the government/economy to promote double-digit GDP growth for the next 25 years with below 4% core CPI

India’s Central Bank RBI took a hawkish hold stance for the last few months and didn’t indicate any potential rate cuts, which is divergent from the Fed’s dovish hold stance and a clear communication of -75 bps rate cuts in late 2024. This boosted INR and USDINR appreciated only +1.45% in the last year; INR is one of the best-performing EM currencies amid India’s stable/improving macros and RBI intervention. But going forward, RBI may officially change its stance from being restrictive to neutral and then accommodative to cut rates by -75 bps from Sep’24 (in line with Fed). RBI has to ensure double-digit real/nominal GDP growth with below 4% sustainable core CPI and limited appreciation in USDINR so that Indian nominal GDP reaches the $7-10T target by 2027-30 under Modi-3.0.

India’s Federal government pays around 45% of core tax revenue as interest on public debt. For FY25, India’s Federal government may borrow around Rs.16.85T to meet a fiscal/budget deficit of the same amount out of which estimated debt interest would be around Rs.12.80T; i.e. over 75% of gross borrowing. If this trend continues, India will soon have to borrow just to pay interest 100%, which is a sign of ‘bankruptcy’ for a normal business house. Although, most of the debt/bondholders of the Indian Federal government are Indian DIIs including LICI, PSU Banks, and RBI; i.e. effectively GOI (Government of India-Federal government), higher borrowing; i.e. higher money printing/flow is creating higher inflation, structural bad for any economy.

But India’s real GDP has to grow in double digits at least +10% CAGR in USD terms in the next 25 years, so that real GDP may grow to around $8-10T by 2050 from the present $2.09T. The supply/infra capacity of the Indian economy has to grow significantly to serve the increasing demand of a growing population. The huge infra (traditional, transport, and social) and fiscal stimulus will also ensure quality employment in India for the ordinary public to avail travel by Bullet trains, Vande Bharat, and airlines, which the government is building.

Thus India needs targeted fiscal/infra stimulus and for this, there is a need for lower borrowing costs; i.e. both lower inflation and lower bond yields and RBI needs to cut the repo rate to at least by -2% to +4.50% from present +6.50% by next few years (FY26) with limited LCU devaluation. India needs to improve its labor productivity above wage increase levels for lower inflation and a better standard of living.

After staying range bound between 80.90-83.55 since Oct’22 and around 83.00 for most of 2023, thanks to almost 24/7 RBI intervention and India’s stable macros, USDINR jumped from around 83.00 to 73.72 on 22^nd March amid strength in the dollar index (lower Chinese CNY fixing by PBOC and pressure on Japanese Yen dragged all Asian currencies including INR) and the perception that after India’s political funding scam exposed (electoral bond fiasco), political/election funding will go black/unaccounted money mainly through hawala (unofficial FX route) route. Historically, USDINR appreciates by around 5 points every 5 years, especially ahead of the general election.

Also last week, in its monthly economic review, the Indian Finance Ministry stated that higher freight costs and insurance premiums for trade in the Red Sea due to Houthi attacks place significant risks on India’s inflation and make Indian exports less competitive, pressuring growth and weakening the rupee.

Despite running a substantial trade deficit, along with the current account deficit (CAD), Indi’s overall Balance of Payment (BOP) is quite manageable due to robust remittances, even if we do not consider volatile/unpredictable FPI and FDI flows. This along with negligible public debt in FX (external debt), the Indian economy is largely insulated from FX bankruptcy issues like we have seen with some EMEs in the past.

As India is largely an import-oriented economy, especially for fossil fuel (oil), running dual deficits (trade and current account deficit), elevated oil prices, and increasing imports from the US instead of Russia (due to various sanction issues), may pose some risk in the coming days. Oil is now hovering around $83, meaningfully higher than the $68 area at the start of the year (2024). Looking ahead Russia and Saudi Arabia may orchestrate some rally to $90-105 in oil to ‘teach a lesson’ Biden ahead of the Nov’24 Presidential election. If oil indeed soars to $90-105 areas in the coming days due to lingering geopolitical tensions (Gaza, Red Sea, and Ukraine war) and OPEC+ production cut agreement extension, India may face some difficult times as it imports almost 85% of its consumption.

Looking ahead, the Fed may go for an appropriate QT trajectory to bring down the balance sheet from the present $7.5T to around $6.55T, ensuring adequate liquidity (@20-23% of estimated CY24 nominal GDP) for the US funding/money market to avoid the late 2019 QT tantrum (REPO market disruption), which forced Fed to launch a small-QE late Sep’2019, much before COVID disruptions.

Previously the market was estimating the Fed’s B/S size around $6.95T after QT, which soared to almost $9T post-COVID QE. The market was also expecting Fed rate cuts from Mar-June’24, but the Fed is now indicating later, most probably from Sep’24. Despite being contradictory, the Fed may go for both rate cuts and continue QE (even at a slower pace around $0.075-0.050T/M from the present pace of 0.095T/M) till at least May 25-Dec’25. This is hawkish than earlier expected; the Fed is preferring higher for longer policy. Thus USD/US bond yield is now getting a boost and USDINR is now 83.50 areas, which was previously seen as a red line, RBI ready to protect.

Over the last few decades, USDINR usually appreciates by around 5-10% every 5-year election cycle; usually appreciates before any general election and falls back to some extent after the election. Apart from global/local macros, unofficial funding of elections/political parties through the hawala route also affected the currency. Higher USDINR ensures a higher amount of INR (LCU-Local currency) at the hands of political parties even for the same amount of USD someone sent 5 years back.

Also, Indian inflation/CPI is increasing +5% on an average consistently on average, which is boosting USDINR. The demand for USD as a preferred global reserve currency for trade settlement is also positive for USD. Thus despite political and policy stability for the last 10 years under PM Modi, USDINR appreciated almost +40%, which is also supporting export-heavy Nifty earnings to a great extent (such as RIL, INFY, TCS/various techs and pharma companies-exporters).

Although, as an import-oriented economy, higher USDINR is generally not good for the economy, Indian governments, be it UPA/INC or NDA/BJP always prefer an elevated USDINR, which helps India’s exports and also keeps overall imported inflation under control. Higher USDINR usually causes higher imported inflation, especially for fuel and some other commodities; fortunately, unlike many European countries and EMEs, India is not heavily dependent on imported food for its huge population.

This time, whatever may be the fundamental narrative, technically if USDINR now sustains above 83.75 for a few days, then it may scale 85.75-86.50 in the coming days/weeks depending upon India’s general election outcome probability and Fed/RBI action. USDINR was around 70 in early 2019. Higher USDINR is generally positive for Nifty earnings as almost 60% of Nifty EPS comes from export activities.