The Indian Rupee (INR) reached a record low against the US Dollar in August 2013, slumping over 20% as investor confidence in economic management plummeted. The Rupee has since rebounded on a combination of economic optimism and a renewed commitment to fighting inflation by the central bank under a new governor. We expect that this rebound will gather momentum in 2014 as fundamentals continue to improve. We expect INR/USD to trade back towards55, as foreign investment flows begin to gradually return and liquidity concerns surrounding the start of US Fed tapering of its US bond purchasing program are in the rear view mirror.

Capital Outflows

While most developed countries would welcome India’s real economic growth of 4.4% in Q2, this represents quite a slowdown from the heady 9-11% growth rates the country was experiencing three years ago. The slowdown in growth together with a large current account deficit and rising inflation has not been a good combination for the Rupee.

Outflows of short term capital from India sparked the initial slump of the Rupee. Investors fled the currency, pushing it to a record low of nearly 69 against the USD in August. The central bank instigated emergency measures in July, raising interest rates to counter fund outflows and help stabilise the Rupee’s plunge. The central bank also set up two swap programs which allow banks that attract foreign funding to swap those funds for Rupees at a lower rate than prevailing market rates. The intention is to attract foreign funding and reduce the external financial burden.

The central bank has now extended the programs and so far they have attracted US$22.7 billion, an amount equivalent to the current account deficit, helping bolster the external financing position. Since the new measures have been put in place, the Rupee has rallied by 10 % to around 63 per USD. With the stabilisation of the currency and the inflow of investor funds, the RBI has begun to normalise policy by reducing emergency rates back to historically defined targets.