A Fresh Bout Of Rupee Weakness Risks Slowing The Indian Economy, Says Moody's Analytics

A fresh bout of rupee weakness could force the Reserve Bank of India to intervene, risking a slowdown in the Indian economy, according to Moody's Analytics. 

The risk of currency weakness in emerging Asia is especially worrisome given its status as the cradle of the emerging markets recovery, Moody's Analytics said in its March 23 note. "Nowhere is this risk greater than in India, where a new bout of rupee weakness could force the Reserve Bank of India to press harder on the brakes, slowing what we expect to be one of emerging Asia’s best-performing economies," it said.

Policymakers raised rates in the bank’s February meeting, which was marked by a rare dissent from two of the bank’s six board members, the note said. While inflation is no longer rising, higher food prices are a key concern, the report said.

Both dissenting members advocated for a pause to assess the impact of previous tightening on the economy and to rely on incoming data to inform further hikes. Although the meeting’s minutes showed only one member has been concerned with the Fed’s pace of tightening, this could quickly change when the bank meets in April, especially if faster Fed tightening and market jitters cause the rupee to weaken further, the note said.

"Emerging markets are not in the eye of the storm coursing through the U.S. banking sector, but they are in its orbit," Moody's Analytics said.

Major emerging market currencies were mostly unchanged in the days following the closure of Silicon Valley Bank and the spread of liquidity troubles to other U.S. regional banks and Swiss banking giant Credit Suisse, the note said. But portfolio flows to emerging markets, a key gauge of sentiment toward emerging economies and a prime mover of EM stocks, currencies, and bonds, slipped into reverse after staging a wholehearted comeback in January and February, it said. While this raises concern about a broader global recession and its impact on emerging markets, it is too early to call for the curtain on the emerging markets' recovery, the note said. "Grounded by our conviction that the U.S. banking system will hold firm, we are sticking to our call for most major emerging economies to grow this year," Moody's Analytics said.

They will be supported by China’s economic rebound and the return of growth in Europe, and by a Federal Reserve that must now balance risks to financial stability as well as inflation, it said. "While we have pared our expectations for U.S. growth this year and next, the outlook for emerging economies is largely intact."

China’s rebound will bolster the newly industrialised economies of South Korea and Taiwan, the note said,  adding that Chinese tourism and demand for commodities and electronics will do much to lift Southeast Asia. "Firming oil demand from China will support energy producers in the Middle East."