‘Indian Rupee could face further depreciation…’: RBI’s new challenge of a strengthening US dollar — expert advice

Q2 results have nearly come to an end. The outlook on Q2 results was muted, and the actual performance is marginally lower than the preview. This is leading to a downgrade in earnings. The Nifty50’s PAT was forecasted to grow by 8.4% YoY, but the current actual growth is around 6.6%, with three company results to be released as on 13th Nov. Revenue growth was modest at 2.8% YoY, falling short of the 4.2% forecast and significantly lower than the 7.6% YoY growth observed in Q1. 

While the numbers are not significantly worse than the estimates, the domestic market’s current fallout has been more severe. This is because the market is coming to terms with the fact that India can no longer trade in the premium valuations it has enjoyed over the past 2-3 years. As future earnings growth moderates, valuations have not adjusted accordingly. Consequently, we are now experiencing the impact of the downgrade in India’s valuation.

In Q1, the PAT growth was 6.7%, and Q2 is concluding similarly, suggesting that H1 growth will be around 6.6%. On a positive note, market optimism suggests that H2 will be better than H1. This is due to an increase in government spending, which had declined in H1, as the government plans to maintain the FY25 budget expenditure. However, because of weak H1, analysts have cut the EPS forecast for FY25. For Nifty50, EPS is cut by 2.5%. New EPS estimate is ₹1,121 compared to ₹1,150 a quarter back.

This raises the question of whether the valuation has corrected enough to see a market rebound or improvement in trend. Well, the current valuation of India has reduced to a P/E of 21x on FY25 and 18x on FY26 basis. Which leads to the one year forward P/E of 19.6x, which is 8.4% below 21.4x as of Sept. Today we are trading marginally above the 5yrs average of 19.4x, making it attractive for long-term investors to start chipping into quality stocks for the next 1-2 quarters.

From here on we will have to bear more of a time correction than cut in prices. But the short-term risk persists in the near-term as FIIs continue their selling in November, though at a reduced pace compared to October, which still poses a downside risk to prices. The 5-year +1 Standard Deviation and -1 Standard Deviation stand at 21x & 18x respectively, stating that the upside and downside risk for valuation are +8% and -7%, respectively. However, we believe that the downside is protected, as quarterly earnings are likely to be better on a QoQ basis and expected to improve better in Q4. The outlook for EPS growth is more optimistic for FY26, projected at 14-16%, compared to the downgraded 9% for FY25. 

Today the market commentary is expressing concern about the high CPI of 6.21% in October. Well, that may not be such an issue, as the monthly forecast is expected to moderate in a range of 4 to 5% in Nov and Dec. Additionally, the market would not favour an RBI rate cut at this time due to a new challenge that was previously unaccounted for: the strengthening USD. If rates are cut now, the INR could face further depreciation. As the non-spend government expenditure starts to get reflected in the upcoming monthly high frequency data, market sentiment will improve. 

Historically, the INR depreciates against the USD at a long-term annual rate of3.2%, in the last 20yrs. In the last year the depreciation is low at 1.7%. INR is performing better than other EMs, and the view is that it is expected to be maintained. The strengthening of the USD will only become a significant issue if this long-term trend changes, which seems unlikely even in the event of a second Trump administration, due to the long-term structural strengths of the Indian economy. India GDP is expected to grow at a real rate of 6 to 7% and 10 to 12% on the nominal rate.