The start of August brought a downward movement to the Rupee in the wake of a weaker than expected Indian Purchasing Manager’s report (PMI). Since peaking in April near 77, the Rupee has strengthened against the greenback, rising to 75, before the PMI report showed that that economic output in July was weaker than expected. This comes just days ahead of the next RBI meeting which is scheduled for August 6. The RBI is expected to keep rates unchanged.
Purchasing Manager’s Output Contracted in July
Economic output contracted at an accelerating pace in July in Indian according to information provider IHS Markit. Demand conditional deteriorated at a fast pace than expected as business activity remained subdued. According to IHS, firms that reported to their PMI survey cut staff and reduced purchasing activity. Despite the negative sentiment related to the spread of COVID-19, sentiment toward the future improvided for a second consecutive month according to IHS.
The survey firm reported that the July PMI came in at 46.0 in July, down from 47.2 in June which points to further contraction. The PMI is a diffusion index which means that levels above 50 designate
Fortunately, the decline in output and sentiment led to a decline in prices. IHS reported that input prices declined during July. However, the rate of reduction was modest. Survey participants reported subdued demand for most goods more than offset the inflationary impact from the shortages in some raw materials.
Will Rates Remain Unchanged
The contraction in the PMI in conjunction with lower input prices might be the impetus that the Reserve Bank of India needs to lower rates. The central bank is concerned about inflation and this might be the issue that keeps them from reducing rates when the monetary policy committee of the central bank meets on August 6, 2020. In a survey polled by Mint (RBI), 7 out of 10 economists believe that the central bank will remain on hold. The survey also shows that most economists believe that inflation will remain near the 4% level.
The survey was conducted before the PMI data that input prices contracted in July. Four respondents expect a 25 basis points cut in the repo rate as they believe that get the RBI ahead of the curve. This would occur if the RBI believes they need to look through higher inflation levels given the recent contraction in growth. The RBI has already but interest rates by 115-basis points since the spread of COVID-19 in February of 2020. The RBI cut interest rates by 40 basis points in May shifting from a focus of controlling inflation to one of stimulating growth.
How Could This Impact the Rupee?
The Rupee has been strengthening despite the decline in the repo rate since peaking in April, rising from 77 Rupee per the dollar to 75 Rupee for the dollar in July. Following the IHS report on manufacturing PMI, the Rupee weakened by 0.4% and is poised to move higher ahead of the RBI meeting. The decline in the Rupee is a function of the potential for the RBI to lower interest rates and that the differential between Indian interest rates and US interest rates will move in favor of the greenback.
Since the majority of economists expect the RBI to keep rates unchanged, a decline in rates will likely harm the value of the Rupee. Since any change in rates is expected to be limited to 25-basis points, a decline in rates that is greater than this would likely catapult the Rupee back to the highs seen in April.