The rupee falling to two-year lows may dampen the prospects of an interest rate cut by the Reserve Bank of India (RBI) in September, pouring cold water on Finance Minister Arun Jaitley's call for a cut in key lending rate, given that retail inflation fell to a nine-month low in July.
The rupee has fallen sharply after the Chinese authorities opted for yuan devaluation two weeks ago. Analysts have raised doubts that the step is aimed at keeping the yuan depreciating for long in order to boost its slumping exports.
"If recent depreciation pressure on the rupee persists, we suspect that the central bank will be wary of lowering rates further," DBS said in a research note to Business Standard.
Meanwhile, markets have started expecting a rate cut by the RBI next month after consumer price inflation (CPI) declined to a nine-month low of 3.8% in July due to lower food prices and high base effect.
Stepping up the pressure on the RBI to cut rates, Jaitley said last week that "hopefully, the impact of inflation being under control is a factor which ... the central bank, with all its wisdom, will take note of."
The minister had also called for RBI rate cuts earlier this year, in sharp contrast to the cautious approach followed by the RBI governor Raghuram Rajan.
A media report said that some officials of the finance ministry are even lobbying "behind the scenes for immediate rate cut by as much as 50bps."
In the wake of growing calls for rate cuts, Rajan said on Monday that "rate cuts should not be seen as goodies that the RBI gives out stingily after much public pleading."
"Instead, what is important is sustained low inflation. And rate cuts are a natural consequence that the RBI has no hesitancy in delivering," he said.
At the August policy review meeting, the RBI governor had kept policy rates unchanged, waiting to see how inflationary pressures evolve. Rajan also pressed banks to pass on the benefits of earlier rate cuts to borrowers.
"India's Finance Ministry is treading on dangerous ground with calls for monetary easing and other moves that could put the central bank's independence at risk," said Capital Economics in a note.