Currency outlook 2021

Currency outlook 2021

Last updated: 05 Jan, 2021 | 04:02 pm

Currency outlook 2021

After plunging to a record low of ₹77 against the US Dollar, the Indian Rupee ended 2020 with a 3% decline to 73.30. In New Year 2021, the rupee is expected to remain range-bound, and not depreciate beyond its previous lows.

Factors favouring recovery:

  • Weaker outlook for USD: Various global organisations have indicated that the US Dollar is expected to depreciate, as the global economic outlook improves. When the economic outlook is poor, investors tend to flock to safe havens, which drives up the value of the dollar. This was seen during March and April, when the first-wave lockdowns rolled out around the world. (USD/INR plunged to a record low of ₹77). When global growth expectations improve, other currencies tend to gain against the dollar as capital flows toward opportunities with higher potential returns.
  • Rising FDI inflows: Foreign Direct Investment (FDI) into India grew by 15% to USD30 billion during the first half of FY21. Foreign inflows into Indian equities rose to a record in December, while domestic benchmarks reached new life-time highs. Rising FDI inflows would lead to strengthening of the domestic currency. 
  • Current Account Surplus: India has reported a Current Account Surplus in the last three quarters, owing to lower imports caused by Covid-19 pandemic. This could lead to the Central Bank tolerating a stronger domestic currency (as exports remain higher than imports). 
  • Pause on interest rates: In its latest policy meeting on Dec 4th, RBI kept the policy repo rate unchanged at 4% with an accommodative stance. Going forward, the central bank is likely to keep a pause on rates amid improving growth and rising inflation. This will also provide support for a stronger rupee.

Factors that could lead to depreciation

  • Rising oil prices: With India having a crude oil import dependence for more than 80% of its needs, rising global oil prices driven by a global economic recovery in 2021, will put downward pressure on the Indian currency. According to Fitch Solutions, Indian rupee will trade at an average Rs 75.50 to a US dollar in 2021. This implies marginal depreciation from current levels. 
  • RBI intervention: RBI has been aggressively buying dollars from the spot market to prevent a sharp appreciation in the rupee to ensure export competitiveness.  This is one of the main reasons why rupee has underperformed despite record FDI inflows. According to estimates by HDFC Securities, RBI’s dollar buying would keep the rupee in check. The brokerage believes the pair is expected to trade in a broad range of 71 to 76 in 2021.
  • Higher inflation expectations: Rising global fuel prices along with a global demand recovery will put an upward pressure on inflation. Higher inflation in India vis-à-vis the US should exert weakening pressure on the rupee.

Major industries affected by  a weaker rupee are as follows:

How will this affect investments?

  • A potential weakening of the Rupee hurts the economy as we are large net importers of products and services. A weak currency makes our economy fragile and makes a less attractive investment destination.
  • India has a large amount of external debt (Debt from international financial institutions and foreign governments). The weakening of the Rupee makes our debt even more expensive, increases risk of default and impacts our Country’s sovereign rating (already near junk status)
  • Overall risk of debt defaults in the economy remains high at a corporate-specific level. Sticking to high-quality AAA-rated debt is extremely important. In this scenario, it is better to err on the side of caution.
  • Both equity and debt markets are expected to remain volatile in the medium term.
  • You could hedge your portfolio against rupee depreciation by investing in the US markets directly in Dollars. RBI allows for remittance of $250k per year outside the country.
  • Invest in equities in a staggered manner. Keep your SIP’s running. Stick to large caps and index stocks that are best suited to navigate these turbulent times
  • Stick to AAA-rated low duration funds and bonds over high duration funds at this point in time.