ICICI Direct sees rupee recovering to 78 a dollar in 2023 — key reasons

The Indian rupee ended the year 2022 as the worst-performing Asian currency with an over 11 percent fall. The rupee lost fell from ₹74.46 to ₹82.71 during the year. The currency hit multiple lows in 2022 owing to geopolitical tensions between Russia and Ukraine leading to a steep rise in inflation and aggressive monetary tightening across the globe.

However, brokerage house ICICI Direct believes that the Indian currency is likely to recover this year and appreciate back to the 78/$ level as the economy exhibits resilience to external headwinds.

"The rupee is likely to face resistance near 84 levels and strengthen back to 78 levels in coming months as the Indian economy is in better shape compared to its peers and will be able to withstand any external headwinds," it said.

In 2022, geopolitical uncertainty caused by the war in Ukraine led energy prices to increase. The surge in energy prices led to a rise in inflation and even impacted the current account deficit, noted the brokerage. 

Further, RBI took measures to tame stubbornly high inflation. Since May, it has hiked the repo rate by 225 bps, taking it to 6.25 percent. On top of this, FIIs have sold close to $16 billion in equities in CY22, which has had an adverse impact on the rupee, added the report.

The rupee has steadily depreciated since January, breaking through the psychological level of 80 per dollar for the first time on July 14th, and it maintained the decline to reach a record low of 83.26 per dollar on October 19th. Out of 12 months in 2022, the Indian rupee saw losses in 11 of those months, with September suffering the largest monthly loss of 2.54 percent and January suffering the smallest drop of 0.08 percent.

Going ahead, the brokerage expects relatively high forex reserves to provide a cushion in the event of a global economic slowdown. On top of this, softening crude oil prices will lower import bills and lower growth prospects in other economies are expected to drive FII inflows in India, it added.

Rupee vs peers

The rupee is the second worst-performing currency against the dollar in 2022. Yen shed the most, down 16.2 percent against the dollar in the previous year. Along with Rupee, Pound and Taiwan Dollar also declined by around 11 percent vs the US currency in 2022. Meanwhile, Indonesian Rupiah lost 10 percent vs the dollar, the Chinese Yuan fell 9.5 percent vs the dollar, and Euro lost 6.6 percent vs the dollar.

Key reasons why the rupee is likely to recover this year:

Indian economy: As per the brokerage, the Indian economy is exhibiting resilience to external headwinds and is forecast to be in better shape compared to emerging countries. Inflation has already started moderating and will remain in RBI’s comfort zone in the coming year amid improvement in the global supply chain and as higher interest rates take effect, it added. India's basket of crude oil has also hit a 10-month low of $88.6/barrel in November and India is likely to continue buying discounted Russian crude oil, said the brokerage.

Current account deficit: The current account deficit was at 2.8 percent of GDP in the first quarter and is likely to rise to 4.3 percent of GDP in the second quarter. However, CAD is likely to remain under 3 percent of GDP next year, said the brokerage.

Crude oil and exports: As per ICICI Direct, world economic growth is expected to remain sluggish due to tightened monetary stance and high inflation. Exports may get hit, up to a certain extent. However, a decline in crude oil prices and availability of discounted oil from Russia should keep import bills lower for India, stated ICICI Direct. Additionally, IT (technology services) along with pharma and chemical exports could be India’s stalwarts and provide a silver lining, it added.

Healthy Forex: India’s significant foreign exchange reserves should provide room for the central bank to intervene in the forex markets, if required, said the brokerage. Even the RBI governor in his bi-monthly policy said the size of the forex reserve is comfortable. Higher reserves will provide a cushion in the event of a global economic slowdown and ballooning CAD, noted the brokerage. Also, India’s forex reserves provide more than eight months of import cover, which should prevent a sharp depreciation in the rupee, it noted.

Dollar may tumble to 97

According to the brokerage, the Dollar Index has started losing its strength and is likely to slip further to 97 levels in the coming months as the Fed is likely to take a backseat. The dollar Index may face a strong resistance near the 110 levels.

"Major factors that drove the Dollar index in 2022 like geopolitical uncertainty and monetary tightening have been priced in. Now all focus will be on the Fed's stance on monetary policy. Easing price pressure and looming recession may force the Fed to pause its rate hike and even cut rates by the end of the year," explained ICICI Direct.

Further, the US real GDP growth is forecasted around 0.5 percent in 2022 and 2023. Fed commitment to restore price stability could cause a slowdown in the economy and has also raised the risk of a recession, said the brokerage.

Rate cut seen in the second half

According to the brokerage, the US interest rates are likely to rise to 5 percent in the first quarter of 2023 and then remain near that level in the first half as it takes time for the full effects of those increases to ripple through the economy. US treasury yield curve, the gap between yields on 10-year and two-year treasury notes inverted at -80 bps. An inverted yield curve is often seen as a red flag that a recession is looming, it pointed out.

ICICI believes the Fed may change its stance considering weakening economic conditions and may look at the possibility of cutting rates in the second half of the year towards 4.5 percent.