Why did the Indian rupee fall by a sharp 0.3% on a day when it should be celebrating the 8.2% GDP growth? Indeed why is the rupee one of the worst performing currencies in a year when it demonstrated it is among the fastest growing large economies quarter after quarter.
There was all-round disbelief today that on the first trading day after the country announced a breath-taking 8.2% GDP growth for the second quarter, all financial market instruments--stocks, bonds and rupee--took a tumble. Importantly it was the tumble of the rupee around midday that led to a U-turn in the Nifty, which had at least begun by setting a new all-time high of 26,300.
Here's an effort to decode why the rupee is one of the worst performing currencies among comparable countries like BRICS and ASEAN.
Firstly, India's impressive GDP run--of 7.4% for Jan-March, 7.8% for April-June and now 8.2% for July-September--is not accompanied by a rise in corporate earnings. Indeed the Nifty 50 earnings per share (EPS) has been growing in low-to-mid single digits for the past six quarters, including the latest Q2. While it is common for markets and macros to dovetail each other with a lag, six quarters is a long lean patch, and the poor earnings growth has made valuations look expensive for a year now.
The muted earnings have been a problem for the rupee because it has led to one of the longest period of foreign portfolio outflows--a net $15 billion in FY25 and over $16 billion in Fy26 so far--leading to a capital account deficit for India for two consecutive years. In the past 3 decades, since the rupee became market determined, capital flows were always more than adequate to bridge our current account deficit. India had net FPI outflows and BoP deficits in FY09 (due to Lehman crisis) and in FY12 (due to the taper tantrum). But this is the first time since the marketization of the exchange rate that we have had two consecutive years of BoP deficits i.e. when capital and current accounts are running deficits.
Secondly, FPI flows aren't shunning India just because of modest earnings growth. The additional reason is that India doesn't offer any artificial intelligence stocks, which is the flavour of the day for global equity investors. But then how many EMs can boast of AI stocks? Only the North Asian countries of China, Korea and Taiwan can. But the other countries comparable to India--like the South Asian and BRICs countries--don't have the incremental bad news on their trade account. Countries like Vietnam, Indonesia, Malaysia even Bangladesh have managed to sign trade deals with modest tariffs, while India remains an outlier..
This brings us to the three main incremental negatives that are hurting the rupee:
1. The trade deal with the US was widely expected to be signed by November. That hope got scotched last Friday. Some fresh dollar long positions were taken probably to express that disappointment
2. The October trade deficit of $41 billion--an all-time monthly high--was one of the latest shocks to jolt the rupee. Until then, most economists were expecting India's current account deficit (CAD) to be around 0.7% of GDP, close to the 0.6% of GDP in FY25. But post-November 20, when the October trade data was announced, economists have raised the current year's CAD forecast to 1.2-1.4% of GDP. Now the 1.2% CAD is not high. For the better part of the last 4 decades , India's CAD has been at 2%-2.5% of the GDP. It fell to 0.6% only over last two years since India became a GCC hub. The October trade deficit and consequent raising of CAD forecasts hurt sentiment on the rupee because the market wasn't priced for a 1.2-1.4% CAD. It was priced for a 0.7% CAD and ever since the announcement of the October trade data, the pace of the rupee depreciation has picked up.
3. A third incremental negative is that the market is now pricing that cheap Russian crude won't be available to India and that has had its role in incrementally pushing down rupee bullishness.
4. Finally, several traders pointed out that FPIs are not entirely gung-ho on Q2 GDP numbers. For one thing, the 8.7% nominal GDP growth is a multi-year low for an economy which has posted 12% nominal GDP growth in most years for the past two decades barring Covid and Lehman years. The lower nominal growth, investors fear, can depress corporate earnings.
There is a silver lining though: most experts including the likes of Goldman Sachs and Morgan Stanley are veering around to the view that Indian equities are becoming attractive from a price-point and that the Indian rupee is clearly undervalued. Probably an attractive entry point for the rupee and for Indian equities is just round the corner. Isn't there something about the hour before dawn being the darkest?
