Global economic conditions have changed rapidly in the past month, with intensifying geopolitical shocks from the Russia-Ukraine conflict leading to a pervasive risk-off sentiment and a surge in crude oil prices.

These, together with liquidity tapering and start of rate hikes by the US Federal Reserve, are testing the resilience of the Indian rupee, which has depreciated against the US dollar over the past few weeks, crossing 76/$ as on March 16 from 74.5/$ before the Russia-Ukraine conflict started on February 24. The local currency, though, has been battered less this time, compared with the taper tantrum of 2013 (the last time elevated oil prices and prospects of liquidity tapering by the Fed had rocked the currency).

We look at three key issues in this edition of Insight:

1. Resilience is higher relative to past

Unlike the taper-tantrum episode of 2013, the rupee has held up quite well this time compared to its own past. But then, other emerging market (EM) currencies have also witnessed orderly currency movements by and large, depending on their crude-oil dependence and the extent of repricing of the US Fed’s actions. As a consequence, the rupee has depreciated more than its peers in the past one month. 

2. Risks are real and present

We see the risks clearly tilted to the downside, with an escalation or even delayed de-escalation of the geopolitical conflict pushing up energy prices further and expanding the current account deficit. Assuming crude oil to average $85-90/barrel in fiscal 2023, we do not expect Indian macros to test the levels of 2013, when India was dubbed a part of the ‘fragile five’ — a group of EMs vulnerable to capital outflows due to their weak macroeconomic fundamentals.

3. Ride down is unlikely to be sharp

The rupee is already reacting to the external tensions and, we believe, will depreciate further and settle around 77.5/$ by March 2023. Two factors will play a pivotal role in driving the weakness: higher energy prices widening the current account deficit, and rate hikes by the US Fed resulting in some capital outflow. But with Reserve Bank of India (RBI) expected to continue intervening in the forex markets (thanks to larger forex reserves) to manage volatility, a sharp depreciation in the rupee may be avoided though it could face volatility near term so long as geopolitical tensions persist.