Mumbai: The Indian rupee came under renewed pressure on Tuesday as high oil prices, rising US Treasury yields and strong expectations of a Federal Reserve interest rate increase added to concerns about India's inflation and financial markets.
The rupee weakened to around 95.79 against the US dollar during Tuesday trading, its lowest level in a month. State owned banks were seen selling dollars, which traders believed was likely to have been on behalf of the Reserve Bank of India.
The rupee had already fallen more than 1 per cent last week, ending Friday at 95.55 per dollar. Indian financial markets were closed on Monday for a local holiday.
The latest pressure came as Brent crude oil prices remained above $100 a barrel. Oil was trading around $107 a barrel on Tuesday after renewed tensions in the Middle East raised concerns about supply disruptions.
Higher oil prices are particularly important for India because the country depends heavily on imported crude. A sustained rise in oil prices can increase India's import bill and demand for US dollars, putting further pressure on the rupee.
The oil shock is also adding to inflation concerns in both India and the United States.
India's annual retail inflation rose to 4.82 per cent in August from 4.45 per cent in July, according to government data released on September 14. Food inflation rose to 5.95 per cent from 5.52 per cent in July.
The August inflation figure was the third consecutive month in which inflation remained above the Reserve Bank of India's medium term target of 4 per cent.
The RBI kept its benchmark policy rate at 5.25 per cent at its August meeting. The latest increase in inflation has strengthened expectations that the central bank could consider raising rates at its October meeting. No decision has been announced.
The Indian bond market is also facing pressure. The yield on India's benchmark 10 year government bond ended last week at 7.0233 per cent after rising for a fourth consecutive week.
The RBI is taking steps to reduce excess liquidity in the banking system. It has announced government bond sales worth a total of 1 trillion rupees during September.
The programme includes a 500 billion rupee sale followed by two sales of 250 billion rupees each. The first sale is scheduled for September 17, followed by further sales on September 21 and September 28.
The central bank is using the sales to absorb surplus cash from the banking system and bring short term interest rates closer to its policy framework.
The pressure on Indian markets is closely linked to developments in the United States.
The Federal Reserve is due to announce its interest rate decision on Wednesday, September 16. Financial markets are now overwhelmingly expecting a 25 basis point increase, although the decision has not yet been announced.
Expectations changed sharply after US inflation data showed consumer prices rose 0.4 per cent in August. Annual US consumer inflation stood at 3.4 per cent, while inflation excluding food and energy rose 2.4 per cent over the year.
The stronger inflation figures increased expectations that the Federal Reserve may need to keep interest rates higher for longer to control price pressures.
The US 10 year Treasury yield has also moved above 5 per cent, reaching its highest level since 2007. Higher US yields can make dollar assets more attractive and place additional pressure on currencies such as the rupee.
India's foreign exchange reserves have reached about $785 billion, giving the RBI significant capacity to intervene in the foreign exchange market and reduce excessive volatility.
However, the central bank faces a difficult balance. It must manage the rupee and excess liquidity while also watching inflation and the effect of higher oil prices on the wider economy.
The immediate direction of the rupee and Indian bonds will depend heavily on the Federal Reserve's decision, its guidance about future interest rates and developments in oil prices.
If the Middle East disruption continues and crude remains above $100 a barrel, India's inflation and foreign exchange pressures could increase.
For now, markets are watching whether the RBI can limit further weakness in the rupee and whether the Federal Reserve's expected rate increase will be followed by further tightening.
The Fed decision is still pending, and the future path of US and Indian interest rates remains uncertain.