Volatility is the only certainty

The value of the rupee will be shaped by the interplay of global and domestic developments.

Dharmakirti Joshi
The rupee has shown remarkable resilience since its sharp plunge following the 'taper tantrum' of August 2013. Since then, not only did India exit the ignominious 'Fragile Five' club, the rupee also became one of the most stable currencies in emerging markets. It depreciated 1 per cent against the dollar in FY2015, and 7.1 per cent FY2016.

The three big surprises of 2016 - the Brexit vote, Donald Trump's election as the US president, and demonetisation - meant the Fed interest rate hike in December had only a moderate effect on the rupee. Between January and December 2016, the currency depreciated just 1 per cent against the greenback, compared with a much sharper fall in some emerging market currencies such as the Turkish Lira, which plunged 16 per cent. Rattled by Brexit, the British pound slid 15.1 per cent.

Today, India is much, much better placed to withstand the global storms. A stable political environment and improvement in India's macros such as a sharp reduction in the current account deficit (CAD), low inflation, and gradually improving growth prospects, have created a significant 'pull factor' for capital flows over the past few years. Even as demonetisation tamps down GDP growth, India may still turn out to be the fastest-expanding large economy, clocking 6.9 per cent growth in FY2017.

In calendar 2017, the value of the rupee will be shaped by the interplay of global and domestic developments. The year is likely to be turbulent from a global perspective. The events to watch out are the Brexit process, the economic plan of the US President-elect, the elections in France and Germany, commodity prices, and the rapidity of rate hikes by the US Federal Reserve. Interestingly, most of these risks have a political basis.

All these have the potential to roil the financial markets. In addition, the value of the rupee will also be shaped by domestic developments such as how quickly the economy recovers from demonetisation, the announcements in the Union Budget, timely implementation of the GST, and which way the factors of external vulnerability are headed.

The key question is whether the rupee will remain as resilient as it has been in 2016. Even in normal times, currency forecasting is a hazardous vocation. With so many moving parts as now, it becomes truly forbidding.

Our base case is that the rupee will remain relatively stable in 2017 for the following reasons:

    If the cash crunch spawned by demonetisation and the ensuing consumption slowdown is restricted to the third and fourth quarters of the current fiscal, and we are blessed with another normal monsoon, economic growth can inch closer to 8 per cent in FY2018.

    We expect consumer inflation to be curbed ~5 per cent, the current account deficit within 1.5 per cent of GDP, and the path of fiscal rectitude to continue.

    We also expect GST to be implemented by September, and a pro-growth Budget.

These will afford the 'pull factor' for foreign capital. That's why the rupee will see only a mild depreciation against the US dollar. Yet, there will be volatility depending on how global events shape up.

With Indian interest rates remaining soft, aggressive rate hikes from the Fed will increase the interest rate arbitrage and can engender capital outflows from the domestic debt market. Adverse developments in the Chinese economy can also roil the rupee. For China, 2017 will be a year of political transition even as economic imbalances grow.

But strong fundamentals will safeguard the Indian economy against excessive volatility and sharp depreciation in the rupee - as had happened in calendar 2016.

If the cash crunch lingers and its economic impact spills over to the next fiscal, the rupee will be more vulnerable to global shocks and depreciate faster.

Net-net, currency volatility is the only certainty for 2017. Setting the domestic house in order and focusing on reforms only can ensure relative stability in the currency.

The writer is Chief Economist, CRISIL