COLUMN - Economic malaise leaves India's rupee vulnerable

Indian currency notes are stapled to form a garland at a market in Srinagar May 20, 2008.

(Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own)

By Neal Kimberley

LONDON (Reuters) - The Indian rupee may be poised to slide as economic data from Asia's third-largest economy disappoints and complicates central bank policymaking.

The rupee could easily fall to the 55.38 level against the dollar, last seen on January 8. Beyond that, dollar/rupee levels above 55.50, not seen since November, would beckon if any move gathered pace.

The overall economic outlook for India is not encouraging.

Industrial production unexpectedly shrank for a second successive month in December, hit by weak investment and consumer demand.

The index of industrial production fell 0.6 percent annually, the Central Statistics Office said.

The latest macroeconomic data provides little evidence of the economy picking up markedly in the short term, with India on course to end the 2012/13 fiscal year in March with its slowest growth in a decade at 5.0 percent.

Preliminary gross domestic product estimates showed India's annual growth would probably cool to 4.6 percent in the six months through March, down from 5.4 percent in the first half of the fiscal year.

That will only add to the pressure on Finance Minister P. Chidambaram's to unveil a growth-oriented budget on February 28.

But the minister's room for manoeuvre is limited as India already has a swollen fiscal deficit, which has put the country's investment grade credit rating at risk.

This "grim" fiscal deficit means it will be difficult to sustain spending in 2013/14, rural development minister Jairam Ramesh said on Monday.

The private sector may also be reluctant to pick up the investment baton.

India's rising trade deficit is also a problem.

The deficit for January was $20 billion, the second highest ever, piling pressure on a widening current account gap.

The central bank is worried that India's ability to fund the current account shortfall is becoming increasingly stretched, and could lead to fresh pressure on the rupee.

"We are financing our current account deficit through increasingly volatile flows," Reserve Bank governor Duvvuri Subbarao said on Monday.

The central bank's policy options are themselves arguably limited.

The Reserve Bank cut its benchmark interest by 25 basis points to 7.75 percent on January 29, but struck a cautious note on further easing given the current account deficit.

Given that India's consumer price inflation edged higher to 10.79 percent in January from 10.56 percent a month ago, data showed Tuesday, the central bank's note of caution may be have been doubly prescient.

The Indian rupee looks exposed.

(Editing by Nigel Stephenson)