After unexpectedly benefitting from the largely surprising 0.5 per cent interest rate cut from the Reserve Bank of India (RBI) earlier this month, the recovery in Indian Rupee (INR) momentum has come to a pause as the INR advances back towards 65. To be honest, it was really surprising that the currency gained from another interest rate cut with this being all the more unexpected considering that the RBI cut interest rates by a further 50 basis points (bps).

There are a couple of reasons why the unexpected recovery in the INR might have come to a pause, with one of the most likely arguments being that investors have reacted negatively to another interest rate cut by the RBI which could encourage capital outflows. Apart from this, the sentiment towards the emerging markets remains weak anyway with investor sentiment towards these markets being punished by the depressed commodity prices and elevated fears over the China economy entering a deep downturn.

While depressed commodity prices are a benefit to the Indian economy when you take into account that India is an importer of commodities, it has added unexpected inflation risks and played a factor in influencing the RBI’s motivations to cut interest rates multiple times throughout 2015.

In regards to China entering a further economic downturn, it has been repeated on a variety of occasions that slowing economic momentum in China is actually not a huge problem for the economy itself as a growth rate close to 7 per cent is still phenomenal. It will only cause anxiety when it begins to impact local employment. The threat is to the wider economy because so many economies are reliant on trade with China, and they are basically going to suffer the fall-out of slowing growth in China because there will be less demand from China for exports.

This impacts the emerging and Asian markets more than most because it is those economies that find their own GDP growth being reliant on consistent trade with China. Where the INR trades until the end of the year remains a difficult call. The positive news is that currency volatility has dropped from a 15-month high in August towards a two-month low this month with this providing encouragement that the currency is starting to show stability.

A major factor in possible future INR volatility would be dependent on whether the RBI threatens further interest rate cuts. With that being said, there is some confidence that after multiple interest rate cuts throughout 2015 the RBI might now monitor economic data to see if the stimulus moves are having a positive impact on data before considering easing monetary policy even further.

-Jameel Ahmad,

Chief Market Analyst, ForexTime