By Mihika Sharma
The Indian rupee strengthened marginally by 0.1% against the dollar in June, closing at 83.39. While factors such as a strong dollar, higher crude oil prices and a depreciating yuan weighed on the rupee, net foreign portfolio inflows offered support.
The dollar index (DXY) strengthened by 1.1% to 105.9 in June, driven by weakness in the Euro (EUR) and Japanese Yen (JPY), even as economic data suggested easing inflationary pressures in the United States.
EUR/USD depreciated by 1.2% due to political uncertainty ahead of France’s elections, while the JPY fell by 2.3% against the dollar to its weakest level in nearly four-decades amidst the Bank of Japan’s gradual approach towards monetary policy normalization.
Inflation in the US, as measured by Core Personal Consumption Expenditures (PCE) price index – the Fed’s preferred gauge – declined to 2.6% year-on-year in May from 2.8% in April, in line with market expectations and marked the lowest rate since March 2021.
This confirmed the disinflationary trends observed in earlier CPI and PPI data. The market expects the Fed to start rate cuts, likely by 25 basis points (bps) in September, followed by another 25bps in December.
Brent crude oil prices surged sharply by 6% in June to USD 86.4 per barrel as escalating geopolitical tensions in the Middle East and Russia-Ukraine raised concerns about potential supply disruptions.
The weakening of the Chinese yuan (CNY) added further pressure on the rupee. The yuan has depreciated 2.4% year-to-date against the dollar and is currently trading near its lowest level since November 2023.
This depreciation is a result of the monetary policy divergence with the Fed. Additionally, the People’s Bank of China’s (PBoC) weak daily fixings of the CNY signal that the PBoC may allow the yuan to weaken gradually.
The rupee received some support from FPI inflows in June. FPIs turned net buyers in the equity market in June after two consecutive months of selling. Net inflows into equities amounted to USD 3.2 billion, compared to net outflows of USD 3.1 billion in May and USD 1 billion in April.
Among other things, expectations of policy continuity under the new government led FPIs to increase their exposure to Indian equities. Further, net FPI inflows into debt rose to USD 1.8 billion in June from USD 1.0 billion in May, ahead of the inclusion of government bonds in JPMorgan’s widely tracked emerging market debt index on June 28.
The bond index inclusion is expected to gradually attract FPI inflows of about ~USD 20 billion up to March 2025. Overall, net FPI inflows increased to USD 5 billion in June from net outflows of USD 1.5 billion in May.
Another positive development for the rupee was that India recorded a current account surplus in Q4FY24. Current account surplus stood at USD 5.7 billion (equivalent to 0.6% of GDP) in Q4FY24 compared to a deficit of USD 8.7 billion (~1% of GDP) in the previous quarter and marking the first surplus since June 2021.
A lower merchandise trade deficit supported the current account balance. Merchandise trade deficit narrowed to USD 50.9 billion in Q4FY24 from USD 69.9 billion in Q3FY24. For the full fiscal year FY24, India’s current account deficit narrowed to 0.7% of GDP from 2% in the previous year.
Additionally, the balance of payments recorded a surplus of USD 63.7 billion in FY24 compared to a deficit of USD 9.1 billion in FY23.
Looking ahead, the upcoming week will be pivotal with focus on key US labour market data. The JOLTS job openings report is scheduled for release on Tuesday, followed by nonfarm payrolls on Friday.
Both indicators are expected to decline, signalling a softening in labour market conditions, which could increase the likelihood of a Fed rate cut in September.
Market focus will also be on Fed Chair Jerome Powell and European Central Bank (ECB) President Christine Lagarde, who are set to participate in a panel discussion at the ECB’s annual forum. Market observers will be closely looking for any indications regarding future policy actions.
On Wednesday, the release of the minutes of Fed’s June meeting will offer further insights into the Fed’s economic outlook and policy considerations.
Political events will also be in focus, with elections scheduled in France and the UK. Polls show the far-right National Rally party leading in the first round of France’s elections, with the second round scheduled for July 7.
Market participants are concerned that a new government in France could increase fiscal spending at a time when the country’s fiscal outlook is already under pressure. This is expected to maintain pressure on the EUR and keep the dollar index firm.
Meanwhile in the UK, the opposition Labour Party is expected to win in the upcoming elections on Thursday, which is likely to be a positive development for the GBP.
Additionally, China’s Caixin PMI numbers will be in focus this week after official National Bureau of Statistics (NBS) PMI numbers showed that manufacturing activity contracted for the second consecutive month in June.
While the NBS non-manufacturing PMI remained in expansionary zone, it fell to a five-month low. Weak economic data is likely further aggravate yuan’s weakness. We expect the USD/INR to trade between 83-83.70 in the near term. A strong dollar, elevated crude oil prices and weak yuan may weigh on the rupee in the near term.
However, FPI inflows related to the bond index inclusion will provide some support. The Reserve Bank of India (RBI) is likely to intervene as needed on both sides to limit the rupee’s volatility.
(About The Author: Mihika Sharma is Associate Economist at CareEdge Ratings.)
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