The Indian rupee is facing increased volatility in the foreign exchange market as the US Federal Reserve and the Reserve Bank of India (RBI) are expected to take divergent policy actions in the coming months. The Fed is likely to raise interest rates and taper its bond purchases, while the RBI is expected to maintain an accommodative stance and support growth.
The Fed has signaled that it is ready to start raising interest rates and reducing its bond purchases as soon as next year, as inflation in the US has surged to a 13-year high of 6.8% in November. The Fed’s latest projections show that it expects to hike rates three times in 2023 and three more times in 2024, bringing the federal funds rate to 2.1% by the end of 2024. The Fed also plans to reduce its monthly bond purchases by $15 billion starting in January, and end them by March.
The Fed’s hawkish stance has boosted the US dollar and increased the demand for safe-haven assets. The dollar index, which measures the greenback against a basket of six major currencies, has risen to a 16-month high of 96.8. The US 10-year Treasury yield has also climbed to a 10-month high of 1.7%.
RBI Maintains Accommodative Stance
The RBI, on the other hand, has maintained an accommodative stance and kept its policy repo rate unchanged at 4% since May 2020. The RBI has also continued its quantitative easing program, under which it has purchased government bonds worth Rs 4.2 trillion in the current fiscal year. The RBI has said that it will continue to support the recovery of the Indian economy, which grew by 8.4% in the second quarter of 2023, after contracting by 7.3% in the previous fiscal year.
The RBI has also said that it will remain vigilant and monitor the inflation situation closely, as consumer price inflation in India has remained above the RBI’s target range of 2-6% for most of 2023. In November, inflation eased to 4.9%, but core inflation, which excludes food and fuel prices, remained elevated at 6.1%.
Rupee Faces Pressure and Uncertainty
The divergent policy actions of the Fed and the RBI have put pressure on the Indian rupee, which has depreciated by 3.6% against the US dollar in 2023. The rupee closed at 76.23 per dollar on December 31, 2023, the lowest level since April 2020. The rupee has also faced headwinds from the rising crude oil prices, which have increased India’s import bill and widened its current account deficit. India imports about 80% of its oil needs, and oil prices have risen by 50% in 2023, reaching $80 per barrel in December.
The outlook for the rupee in 2024 is uncertain, as it depends on several factors, such as the pace and timing of the Fed’s rate hikes and tapering, the RBI’s policy response, the global and domestic growth and inflation dynamics, the oil price movements, and the capital flows to emerging markets. Some analysts expect the rupee to weaken further and touch 80 per dollar by the end of 2024, while others expect the rupee to recover and appreciate to 74 per dollar by the end of 2024.
