Indian Rupee weakens after FM Sitharaman hikes Capital Gains tax

Source Fxstreet
  • The Indian Rupee weakens against the US Dollar after the announcement of the Indian Fiscal Budget 2024-25.
  • Indian government raises capital gains taxes with immediate effect.
  • This week, the US Dollar will be influenced by a slew of US economic data.

The Indian Rupee weakens to near 83.70 against the US Dollar (USD) in Tuesday’s European session. The Indian currency faces pressure due to a sharp sell-off in equity markets after the announcement of the Fiscal Budget 2024-25.

Indian Finance Minister Nirmala Sitharaman proposed to hike taxes on Long-term Capital Gains (LTCG) and Short-term Capital Gains (STCG) with immediate effect. The centre has raised taxes on LTCG and STCG from 10% to 12.5% and from 15% to 20%, respectively. While the exemption limit on LTCG has been raised to Rs. 1.25 lakhs from Rs. 1 lakh.

Higher taxes on capital gains are an unfavorable scenario for foreign investors who are keen to invest in India through direct investment or institutional routes. This could have a negative impact on the Indian rupee in near-term.

However, the long-term appeal of the Indian Rupee could strengthen as the administration has reduced fiscal deficit targets for 2024-25 and 2025-26 to 4.9% and 4.5%, respectively.

Meanwhile, the US Dollar exhibits a subdued performance with a focus on a slew of United States (US) economic data, releasing this week. The US Dollar Index (DXY), which tracks the Greenback’s value against six major currencies, trades around 104.30.

The major trigger for the US Dollar will be the core Personal Consumption Expenditure Price Index (PCE) data for June. The core PCE inflation is a Federal Reserve’s (Fed) preferred inflation tool, which provides cues about when the central bank will start reducing interest rates. Currently, financial markets expect the Fed to begin lowering interest rates from the September meeting.

Indian Rupee FAQs

The Indian Rupee (INR) is one of the most sensitive currencies to external factors. The price of Crude Oil (the country is highly dependent on imported Oil), the value of the US Dollar – most trade is conducted in USD – and the level of foreign investment, are all influential. Direct intervention by the Reserve Bank of India (RBI) in FX markets to keep the exchange rate stable, as well as the level of interest rates set by the RBI, are further major influencing factors on the Rupee.

The Reserve Bank of India (RBI) actively intervenes in forex markets to maintain a stable exchange rate, to help facilitate trade. In addition, the RBI tries to maintain the inflation rate at its 4% target by adjusting interest rates. Higher interest rates usually strengthen the Rupee. This is due to the role of the ‘carry trade’ in which investors borrow in countries with lower interest rates so as to place their money in countries’ offering relatively higher interest rates and profit from the difference.

Macroeconomic factors that influence the value of the Rupee include inflation, interest rates, the economic growth rate (GDP), the balance of trade, and inflows from foreign investment. A higher growth rate can lead to more overseas investment, pushing up demand for the Rupee. A less negative balance of trade will eventually lead to a stronger Rupee. Higher interest rates, especially real rates (interest rates less inflation) are also positive for the Rupee. A risk-on environment can lead to greater inflows of Foreign Direct and Indirect Investment (FDI and FII), which also benefit the Rupee.

Higher inflation, particularly, if it is comparatively higher than India’s peers, is generally negative for the currency as it reflects devaluation through oversupply. Inflation also increases the cost of exports, leading to more Rupees being sold to purchase foreign imports, which is Rupee-negative. At the same time, higher inflation usually leads to the Reserve Bank of India (RBI) raising interest rates and this can be positive for the Rupee, due to increased demand from international investors. The opposite effect is true of lower inflation.

 

Disclaimer: For information purposes only. Past performance is not indicative of future results.
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