Why the rupee can't bounce back in a hurry—and other macro risks investors should watch out for

The Indian rupee is back near 96 to the dollar, a level that has prompted the Reserve Bank of India (RBI) to rush to the currency's rescue in recent weeks. Taimur Baig, Managing Director and Chief Economist at DBS Group Research, believes the rupee's ongoing struggle, despite the recent surge in dollar deposits, stems from the broader global context, particularly US bond yields.

He expects both the US Federal Reserve and the Reserve Bank of India (RBI) to remain focused on inflation, with the Fed potentially delivering two more rate hikes this year and another in the first quarter of next year. For India, he sees a couple of RBI rate hikes as consistent with resilient growth, provided inflation remains elevated.

Baig also expects India’s growth to remain in the 6.5-7% range if current headwinds persist, while stronger growth is possible if some of those pressures ease. He sees India’s fiscal position as a key foundational strength and believes an orderly rupee depreciation could support the country’s manufacturing and export competitiveness.

This is an edited transcript of the interview.

Q: Share your observation on what's happening on the macro front. The US market has been in an astounding four-year bull run, and it has absorbed energy shocks, wars, geopolitical stress, etc., on account of the tech boom. Do you see anything putting the brakes on the US market rally?

A: There are many things that can put the brakes on the US market rally, and there are very strong parallels between what's happening in the US and what's happening in India on the issue of shock absorption capacity.

There are issues related to inflation, political uncertainty, the midterm elections, the Iran war — all sorts of things could have tripped up this market. But we have this giant artificial intelligence (AI) tailwind, which is outweighing all those things, shrugging off the higher yield, fiscal dysfunction, everything.

In the case of India, also, we can say that the long list of headwinds could have led to severe downgrading of earnings expectations and growth expectations. But considering all the things that we have, and on top of that, El Niño and all those things, India's economy is doing pretty well.

So, I think the parallel between the US and India is that we should worry about all the things that are legitimately worth worrying about, but we should not downplay some of the foundational strengths. In the case of the US, it is the AI tailwind. In the case of India, it's the fiscal situation, which is looking impressive compared to what's happening in the US.

Q: A question with regard to the US. First, because that's the mother market and that's been the pain point. Inflationary worries are clearly on the table, right? I mean, if you can't have the 10-year yield at these sort of levels, and President Trump is not backing off as well, how do you see things pan out given the kind of inflationary worries? And what are you factoring in in terms of the Fed?

A: In terms of the Fed, at least a couple of more rate hikes may not be the one in the next meeting, given that it's so adjacent to the midterm election.

But I think the Fed, particularly Fed Chair Kevin Warsh, has really backed itself into a corner by making rather hawkish proclamations about the 2% target being sacrosanct and that the Fed funds rate is the operating tool. So there really is no wiggle room left in terms of not being able to follow through with the promises.

Q: So, the second rate hike comes in the December meeting.

A: That's correct, and maybe one more in the first quarter of next year, taking the terminal rate to 4.5%.

In terms of whether the inflation issue and the rates issue are the only issues to worry about, well, I think that the fiscal issue is the big question.

I think the demand for funding is massive on the private sector side, on the data centre financing. But some of that is coming from outside the US, not just necessarily fundraising in the US.

The US government is increasingly reliant on US buyers for its massive Treasury issuance because the appetite from the Chinese is not what it used to be. The appetite from the Japanese is not what it used to be.

So even at the high yield, the domestic US financial sector's capacity to absorb all these issuances is a big question. Again, kinds of things that we used to worry about in India now; those worries are very much front and centre in the US.

Q: Since you refer to India, what do you expect the Reserve Bank of India (RBI) to do? There is some buzz that, probably, we get a rate hike sometime in the next few months. What are you pencilling in? You're sounding fairly optimistic about the Indian economy in this sort of a backdrop, but in terms of the RBI rate action, what are you working with?

A: We think that a couple of rate hikes from the RBI in the coming months is perfectly legitimate, given the fact that inflation bottomed out and is heading into the mid-four handles, perhaps even going a little higher.

So, similar rationale that the Fed has expressed, which is you can't just dismiss supply-side developments, can't just say that these are transient shocks and we're going to look through it. There's a limit to how much you can look through it, especially since there are many second-round impacts from the higher energy prices.

If you believe that the war is not going to go away, if you believe the energy supply-related disruption will continue, you need to worry about the second-round effects and provide some signals to market participants, to day-to-day Indians, that the RBI is very serious about inflation.

So, which is where I think that the conditions are such that RBI can afford to go for a couple of rate hikes and not necessarily derail investor sentiment or make the cost of funding so prohibitive that it undermines the investment cycle.

I'm not worried about those things. I can see a rate hike being fully consistent with resilient, decent growth.



Q: Here in Maharashtra, news reports that drought has been declared in 75% of the state. Any thoughts on that?

A: I think weather-related volatility is here to stay. You're talking about drought in Maharashtra. I was also reading that every single district in Bangkok has been declared a flood area overnight because it's raining so much there.

So, we have feast and famine with respect to rain and lack of rain, and that's certainly going to have an impact in the medium term on agricultural yield.

Now, over the last, say, half a century, we have to take our hats off to the agricultural scientists of the world that they managed to keep crop yields going up, despite all this weather-related volatility.

So, on one hand, amazing scientific advancement is keeping us well fed. On the other hand, the very short-term inflationary impact, supply-side impact, because of increasing variability of weather-related developments, is here to stay as well.

I think the days of us using agricultural output as a massive proxy for gross domestic product (GDP) growth in India are largely behind us.

India is still very much dependent on farm-level employment and farm output, but the non-farm economy's impact on overall GDP and all the things that we talk about, company earnings and so on, is becoming more and more prominent.

So, I wouldn't describe the economy as two-faced. That sounds like a negative connotation, but K-shaped — that there are winners and there are losers in all phases — is getting accentuated.

Whether it is from AI, whether it is from weather, whether it is from the huge return on capital versus rather meagre return on labour, those are things that are here to stay with us.

Q: India versus the rest in the emerging markets. Share your GDP estimates for Korea, Taiwan, China, India for next year, and if you could break them up, especially for China, Korea, Taiwan, AI impact and the non-AI impact on growth.

A: Non-AI impact, okay, not that great. AI impact, just extraordinary.

I have been looking at the production and export cycle of Asia, particularly East and North Asia, for a long, long time. It has never been this strong. Not the 80s, not the 90s, not the post-Asian financial crisis recovery. We have never seen the kinds of numbers we're seeing in terms of production, exports, optimism and earnings.

So, in the case of Taiwan, double-digit growth, double-digit GDP growth. In the case of Korea, which was considered amazing when it grew at 2%, close to 4% growth.

China is a complex situation because of many domestic headwinds, so more of a low-four trajectory.

In the case of India, all these headwinds, if they remain in place, six and a half to seven. If some of them dissipate, past seven.

Q: And Taiwan, you said double-digit for next year, right? How much of it is purely on account of AI's contribution to GDP?

A: So, what we're seeing is that it's becoming hard to distinguish between AI's impact and overall electronics demand because you see we have a very strong green transition phase taking place.

Electric vehicle (EV) sales are going up. I wouldn't necessarily conflate that with the AI demand. This huge EV plus green transition — solar panel, wind turbine demands going up — and the producers who are in that ecosystem in Japan, Korea, Taiwan and China are raking in demand for that, just globally going up a lot.

It goes back to weather-related variability also being a very big secular driver of that build-out.

So, in the case of Taiwan, of course, chip demand, which is largely AI demand, would be, I would say, 60-70% of the overall growth performance.

Q: Let's talk a little bit about currency then. The RBI went in there; they issued their Foreign Currency Non-Resident (Bank) FCNR (B) deposits, and what a response we got! So, the rupee that was falling one way from around 88 all the way to 97, that got stamped. How do you see the rupee pan out from here? The response to the FCNRB was very good, but those macro headwinds are back on the table, which is a bit of an issue.

A: It's not just a macro headwind. There are some technical factors that are fascinating. The 10-year yield of India versus the 10-year yield of the US has never been this narrow. I mean, this is extraordinary.



So that sort of makes it hard for the rupee to be very strong, given that you have to either believe that the risk premium of India is diminishing substantially, or you believe that there is this natural pull toward the dollar, despite all the negative stuff that we talk about the US. Where else would you get 5.5% from a AAA asset? So that, I think, puts the rupee at a bit of a disadvantage.

But at the same time, given that India is aspiring to be a manufacturing hub, given that export competitiveness matters more than ever, you can't really let episodic sequences where the currency sort of becomes misaligned from the rest of the region.

You have to see what's happening everywhere else. Everywhere else, currencies have sold off, and hence the rupee simply will not exist in a vacuum.

Watch the full conversation here



If we're seeing other currencies sell off, it will sell off, and with one big exception, renminbi (RMB) is appreciating, but then it sorts of acts as a strategic advantage for the rupee.

Rupee weakening a bit, RMB strengthening a bit, big competitive wedge opening up for Indian manufacturers. I'll take it; it's totally okay, as long as it's orderly, to borrow a line from the RBI.

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