The Indian rupee hit 13-month lows and bonds fell sharply as markets in the region tumbled on fears about the global economy, raising doubts about whether India can afford to cut interest rates given risks that such a move could trigger foreign outflows.
The rupee's session low of 63.46 on Tuesday was its weakest against the dollar since Nov 13, 2013, when India was in the midst of its worst currency turmoil since the 1991 balance of payment crisis.
But efforts by the government and the central bank to narrow the current account deficit and the election of Prime Minister Narendra Modi have sparked a sharp turnaround: foreign investors have purchased a net $43.4 billion in shares and bonds this year, allowing India to outperform most emerging markets.
The volatility in global markets is now bound to test India's appeal at a time of high hopes the Reserve Bank of India would cut interest rates as early as at its next policy review in February.
Russia sharply increased its benchmark interest rate on Monday, raising concerns about the global economy at a time of sliding oil prices and a weakening China economy. "If the rupee weakness sustains for long, then we could see a delay in rate cuts," said Hari Chandramgethen, head of foreign exchange trading at South Indian Bank.
The partially convertible rupee was trading at 63.37/38 per dollar by 1040, versus its Monday close of 62.94/95.
Traders said the rupee was also hit after data on Monday showed India's trade deficit widened to an 18-month high in November, in part due to surging gold imports. Although the RBI has recently been intervening to smoothen volatilities in the rupee, traders said the central bank had not stepped in so far.
