The Indian rupee weakened sharply to log its steepest fall in more than two years on Thursday as the ongoing India-Pakistan conflict hurt the currency alongside the country’s bonds and equities. The rupee rose at the start of the session but weakened sharply after India said it had “neutralised” attempts by Pakistan to “engage” several military targets in its northern and western regions on Wednesday and early Thursday.
Pakistan said it had shot down 25 Indian drones. India hit “terrorist infrastructure” in Pakistan in the early hours of Wednesday, two weeks after it accused the nation of involvement in an attack in Indian Kashmir in which 26 people were killed. Islamabad had denied the accusation and vowed to retaliate to India’s missile strikes.
Indian markets dropped following the latest statements from the two nuclear-armed neighbours.
The rupee closed down 1% at 85.71 against the U.S. dollar, its worst day since February 2023, after hitting a low of 85.7625 during the session.
Benchmark Indian equity indexes, the BSE Sensex and Nifty 50, ended down 0.5% and 0.6%, respectively while the yield on India’s benchmark bond rose nearly 7 basis points to 6.3983%.
The rupee could continue to face pressure in the near-term and may fall towards 86.50, said Abhilash Koikkara, head of forex and rates at Nuvama Professional Clients Group. Panic dollar buying from importers could pick up, which would add to the headwinds, Koikkara said.
Dollar-rupee forward premiums also jumped with the 1-year implied yield rising 16 basis points to a near one-month high of 2.34%.
The rupee’s 1-month implied volatility, a gauge of future expectations, rose to an over two-year high of 6.3%.
“International investors undoubtedly evaluate geopolitical risk into their assessment of India, contributing to the rupee’s underperformance,” said Samsara Wang, Asian sovereign analyst in New York-headquartered PineBridge Investments’ global emerging markets fixed income team.
“That said, conflicts between India and Pakistan have not had a lasting effect on Indian financial assets, and the impact is likely to be limited and temporary.”