Rupee fall dampens next week's rate cut hope

Weaker rupee will fuel inflation and limit the scope for a rate cut in June 17 policy review

The sharp fall in the rupee since the beginning of May will make things difficult for the central bank, which is on the path of easing monetary policy to revive growth.

Since early May, the currency has fallen more than eight per cent, and is the worst-performing currency in Asia. The fall in the rupee will have adverse impact on both fiscal and current account deficits.

According to market participants, the rupee fall will bring back inflationary pressure a little, as the country imports more than one-third of its crude oil requirements. The weakening rupee will increase the import bill, which will also affect the fiscal deficit and widen the current account gap, which was 6.7 per cent for the quarter ended December. The current account deficit figures for the fourth quarter will be released this week.

"The sharp and sustained weakening of the rupee will make it difficult for the Reserve Bank of India (RBI) to cut rates in June. The rupee depreciation complicates near-term macro management - pushing up inflation, increasing fuel subsidies, and putting pressure on unhedged corporate balance sheets," said Sajjid Chinoy, India economist, JPMorgan.

"The classical central bank response to a depreciating currency is to raise rates as a means of mounting a defence. India's growth dynamics don't warrant a hike now. But it's safe to say, rate cuts - which lower the opportunity cost of holding Indian fixed income assets - look very unlikely at the moment," he added.

A section of experts, however, said RBI should continue to cut interest rates despite the weakening rupee, as inflation has fallen.

"We continue to expect RBI to cut policy rates by 25 basis points on June 17 if the rupee stabilises this week with the dollar settling at about 1.3 a euro. Further measures to contain gold imports should also save $5-10 billion. Finally, the Met (India Meteorological Department) also expects the monsoons to continue to advance on time," said Indranil Sengupta, India economist, Bank of America- Merrill Lynch.

The pressure on the rupee is also because RBI has not intervened but has expressed concerns over the volatility in the exchange rate.