Weak rupee may limit scope for rate cut: Fitch

Declining value of the rupee may limit the scope of further rate cut by the Reserve Bank despite easing of inflation in recent months, credit rating agency Fitch said on Wednesday.

New Delhi: Declining value of the rupee may limit the scope of further rate cut by the Reserve Bank despite easing of inflation in recent months, credit rating agency Fitch said on Wednesday.

"The recent weakness of the exchange rate may, however, complicate policy management and limit the scope for further cuts in RBI policy rates," the agency said in a statement.

Since January 1, the rupee value has fallen by 5.5 percent against the US dollar and touched life-time low of 58.98 yesterday.

The RBI is scheduled to announce its mid-quarter monetary policy review on June 17.

Amid decline in industrial production and easing of inflation, industry has been clamouring for further cut in policy rates.

Fitch said inflation pressures have begun to show more pronounced signs of easing in response to weaker economic conditions and the tightening of monetary conditions by the RBI during the course of 2011-2012.

However, since January 2012 RBI has been reducing the key policy rates and has cut them by 1.25 percent since then.

Falling for the third straight month, retail inflation stood at 9.31 percent in May. It was as high as 10.39 percent in March.

The growth in Index of Industrial Production (IIP), meanwhile, has slipped to 2 percent in April from 3.4 percent in March.

Industry has been complaining that high interest rate has adversely impacted the country's growth prospects.

Referring to Indian banking sector, Fitch said its profitability and capital position will remain under pressure as asset quality continues to gradually deteriorate.

"Nonetheless, Fitch does not view the banking sector as a material risk to macro-financial stability nor to public finances in terms of the crystallisation of large contingent liabilities," said the agency while revising India's credit outlook to 'stable' from 'negative'.

"In coming weeks, we expect policy tools to be used to support sentiment, including further liberalisation of the capital account. Other possible measures may include limited RBI intervention, debt market liberalisation and a relaxation of FDI limits," Barclays said.

It said it maintains a tactical long rupee-dollar position at the moment as it doubts RBI's ability to lower rates next week despite weak growth.

Noting that the rupee is not the only emerging market currency that has been battered, BofA-ML said the debilitating impact of the higher CAD on rupee has come true with sharp currency depreciation of 6 percent since May.

"Near term, the rupee will likely be volatile with global events and the RBI will have to instill confidence in the market," BofA-ML said.

Significantly, it also sounded confident that worst is over saying "most of the depreciation may be behind us as gold imports are coming down and are likely to fall further given measures taken by government; oil prices are stable; and government may be forced to raise flows through NRI bonds."

As per Nomura's estimate, every 10 percent fall in rupee leads to 60-80 bps rise in headline inflation as imports would become costlier.

It, however, noted that manufacturers will absorb part of higher cost due to weak pricing power in the wake of sluggish demand.

On the current account deficit, Nomura said every 10 percent fall of the rupee will raise the CAD by 40 bps of GDP.

Similarly, it pointed out that 10 percent rupee depreciation against dollar should raise the fiscal deficit by about 20 bps of GDP.

It, however, noted that given the threat of rating downgrade, the government would be prompted to stick to its budgeted fiscal deficit target by raising tax revenues.

The brokerage firm also said recent fall may delay the recovery process in the domestic economy. "Asset price volatility and a slowdown in capital inflows could hurt investment, as uncertainty would further delay a revival of the capex cycle," the report said adding that firms with unhedged forex exposure could suffer losses.