India’s rupee touched a two-week low after a key ally of Prime Minister Manmohan Singh quit the coalition, raising questions about whether the government can push forward with policy changes.
Dravida Munnetra Kazhagam, one of nine partners in the ruling alliance, said yesterday it would stop supporting Singh’s administration over its approach to alleged war crimes in Sri Lanka, leaving the government more reliant on regional parties to pass measures to spur economic growth. The central bank cut the repurchase rate by 25 basis points to 7.50 percent yesterday and said inflation and the current-account deficit limit the scope for further monetary easing.
“It is very much a choice between a rock and a hard place for the rupee now,” said Andy Ji, a foreign-exchange strategist in Singapore at Commonwealth Bank of Australia. “There will be constant fear in the market now about how policies are going to be implemented, and there are also macro risks of inflation and the current-account deficit.”
The rupee was little changed at 54.3675 per dollar in Mumbai, according to data compiled by Bloomberg. It touched 54.565 earlier, the lowest level since March 7, and has declined 0.6 percent this week. One-month implied volatility in the rupee, a measure of expected moves in the exchange rate used to price options, rose 8 basis points, or 0.08 percentage point, to 9.26 percent.
The economy expanded 4.5 percent in the three months through December, the slowest pace since 2009, official data show.
Without DMK’s support, the government will be 44 seats short of a majority, and will be dependent on the backing of parties such as the Samajwadi Party and Bahujan Samaj Party, which compete for power in the country’s most populous state, Uttar Pradesh.
Singh’s administration began unveiling policies to jumpstart growth and improve public finances in September after Fitch Ratings and Standard & Poor’s warned the nation’s credit ratings may be downgraded to junk. The government cut a levy on overseas corporate debt, reduced energy subsidies and allowed more foreign investment in industries including aviation and retail.
The rupee has appreciated 1.9 percent versus the dollar since the changes began on Sept. 13. It remains down 7.3 percent in the past 12 months.
Finance Minister Palaniappan Chidambaram said in an interview last week the nation may ease restrictions on foreign-direct investment. He also said Indian companies seem “quite happy” with the rupee at its current level of 54 to 55 per dollar. Last month, he set a budget-deficit goal of 4.8 percent of GDP for the year starting April 1, 2014, 0.4 percentage point lower than this year.
The plan is credible and the threat of Asia’s third-largest economy losing investment-grade status has “clearly receded by quite a few yards,” said Chidambaram.
“The political uncertainty created by the ally party leaving the coalition shouldn’t cause a near-term election but may slow down the government’s reform agenda or take their focus away from this issue,” said Jonathan Cavenagh, a currency strategist in Singapore at Westpac Banking Corp. “That’s something which will weigh on market sentiment.”