Here’s why the rupee will remain weak at least until Arun Jaitley’s budget speech

• Rupee is expected to stay weak as oil prices rise.
  
• Markets fear the Indian government will breach fiscal deficit target.
  
• Higher fiscal deficit hurts government’s ability to spend for economic growth and increases borrowing cost.
  

The rupee closed at 70.49 at the end of last week, capping a 4% decline since the start of the year.This is largely due to the fact that oil prices ticked up and markets have priced in a series of handouts to farmers by the government as an election ploy.

Last year proved to be a mixed bag for the Indian currency. After declining by 14% in the year to October, the rupee rebounded strongly in the last few months of 2018 owing to the decline in oil prices, and closed at 69.71.

The value of the rupee has significant implications on India’s fiscal deficit and vice versa. When the rupee declines, the fiscal deficit, which measures the difference between government expenditure and revenue, widens because oil becomes more expensive to import. On the other hand, if India’s fiscal deficit widens, it causes foreign investors to lose confidence in the economy and hence they pull money out of the country, which further weakens the currency.

With oil prices expected to grow sluggishly in the initial period of year, the rupee is expected to stay weak. However, the unveiling of the Union Budget on 1 February by Finance Minister Arun Jaitley could provide markets and currency speculators with some much-needed clarity as to where the rupee will go in 2019.

The Budget, which will be an interim budget since it is an election year, will likely include a conclusive statement on whether the central government will breach or meet its fiscal deficit target for the year - which is 3.3% of GDP.

The target has looked increasingly unrealistic in recent months, due in part to lower indirect tax collections, a slow disinvestment process and concessions to farmers. While the government has tried to curtail its capital expenditure, this might not be enough.

“It will be quite difficult for the government to achieve its target as the fiscal deficit is currently in the region of 3.9% of GDP” says Gaurav Sharma, a senior manager at Religare Securities. Sharma explained that if this came to pass, it “would seriously hurt the rupee”.

However, if the government breaches its deficit target, it will exacerbate investor worries, as a high deficit threatens India’s ability to spend for economic growth and increase it’s borrowing cost.

There is room for surprise, though. Even if the fiscal deficit is wider, but less than experts’ predictions, it could provide support for the currency.

On the other hand, with elections due in May 2019, the government expected to play into the desires of key voter blocs, and as such, could include further promises of loan waivers and additional financial largesse.

The central government, for its part, has said that it will meet its fiscal deficit target. Towards the end of December, Jaitley said that the 3.3% mark was in sight, and subsequently clarified that the government would not require a surplus from the central bank’s coffers to meet its goal. As things stands, until the interim budget is unveiled, it seems that all bets are off.


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