Yuan effect: Rupee may weaken further, says Citi

According to Citigroup the Indian rupee is likely to adopt to a new fair value

India seems to be less vulnerable to China's currency depreciation through direct channels, but the rupee may still weaken, says a Citigroup report.

According to the global financial services major, the surprise element associated with the yuan's depreciation may force investors to liquidate their positions across markets.

"It is through this channel that long investor positioning in Indian assets, including Indian rupee may come under pressure.

"Hence, even as the Indian rupee may outperform other vulnerable emerging market currencies, it may weaken against the US dollar," Citigroup said in a research note.

The rupee is currently hovering around Rs 65/USD at 2-year lows.

It has slipped significantly in the last few trading sessions.

"India screens less vulnerable to China's currency depreciation through direct channels, but INR may still weaken," the report said.

Faced with sluggish economic growth and dwindling exports, Chinese apex bank decided to devalue its currency, following which yuan has fallen almost 4 per cent in two days.

According to Citigroup the Indian rupee is likely to adopt to a new fair value, "so as to not tighten the overall monetary conditions incrementally".

China's surprise decision to devalue the yuan sparked a sell-off in global currencies. The ones that were worst hit were those from economies whose exporters either rely on Chinese companies to buy their products or compete with their exporters for customers.

"Taking into account the actual depreciation in Chinese currency, we estimate that the fair value of Indian rupee based on productivity adjusted REER has shifted to 64-65 range from 63.5-64.5 earlier," Citigroup said.

In the event of further devaluation in the Chinese currency, the fair value could shift higher to 64.5-65.5 range, it added.

The Citigroup report further said that a weaker Chinese currency with respect to Indian rupee could make imports of -- electronics goods including telecom equipment, industrial machinery, steel and fertilizer -- more competitive and could impart further disinflation in manufactured products.

"India's BoP situation remains favourable on account of low crude prices and robust FDI flows, but in an environment of widespread emerging market depreciation – competitive or otherwise -- perhaps RBI will be less averse to weaker Indian rupee in the short run," the report added.

Image: A man counts rupee notes in a bank. Photograph: Reuters