The rupee breached the psychologically important 80 to the dollar mark on Thursday on fears that portfolio investors will hasten sales of equities amid fears that the US Fed will raise interest rates by 1 percentage point later this month to restrain runaway inflation. On Friday, the Indian currency opened 5 paise lower at 79.92. So far in 2022, the Indian rupee has depreciated more than 7 percent against the US dollar, plunging from 74 at the start of the year to about 80 now.
Why has the rupee fallen?
The rupee’s fall is mainly due to high crude oil prices, a strong dollar overseas, and foreign capital outflows. A stronger dollar and weak domestic growth prospects is leading investors to flock to safe greenbacks, ditching riskier Indian assets. The US dollar has been strengthening as global investors piled on the safe-haven currency with the US Federal Reserve tightening monetary policy more than peers. Risk aversion in global markets means funds are now flowing back to the US.
Continuous FII selling has been a major drag, which has exceeded $30 billion so far this year though the selling has eased in recent days.
Comsumer Price inflation in the US came in at 9.1% in June, higher than a consensus estimate of 8.8%. Following the hot reading, analysts are now betting that the Federal Reserve may hike by a full point later this month following its larger-than-usual move in June. The US central bank has already raised interest rates by 150 basis points in 2022. One basis point is 0.01%.
“The aggressive policy course by the US Fed to curb rising price pressures is exacerbating fears of a weakening growth outlook and leading to risk aversion in the markets” said Sugandha Sachdeva, Vice President – Commodity and Currency Research, Religare Broking Ltd.
Although the Reserve Bank of India has taken several measures recently to ensure foreign currency inflow and prop up the rupee, such as higher overseas borrowing limits for companies and easier foreign ownership rules in government bonds, the rate of returns in the bond yields in the USA has been more compared to the rate of returns in any Indian investment.
RBI has also proposed the rupee settlement mechanism, under which foreign companies can make foreign payments in rupees, unlike the US dollars. This is expected to reduce the need for US dollars for foreign trade, stabilising its value.
“The rupee has been under pressure and trading at its all-time low as the higher-than-expected June US Inflation data has increased the probability of a 100 bps rate hike by the Fed, further, the relentless FIIs selling has exacerbated the issue. Another point to note is that the Indian forex reserves fell to the lowest level in over 14 months, making it an impediment for the RBI to control the further downside on the rupee. Recently, RBI allowed banks and traders to invoice and settle global transactions in rupees. This is a longer-term step to make the rupee more international nevertheless, we don’t expect any short-term respite due to this move,” said Santosh Meena, Head of Research, Swastika Investmart Ltd.
What happens when the rupee touches 80 against US dollar?
Imports will become more expensive: When the dollar strengthens against the rupee, importers will have to pay more for the same number of dollars. And since international trade is mostly in the US dollar, importers have to pay higher prices. So, a depreciating rupee will increase the cost of imports, putting extra pressure on people’s pockets in the country which has an import-oriented economy. Moreover, a rise in the price of India’s main import item—crude oil—will expand the country’s current account deficit since India imports 85 per cent of the crude oil needed. The war between Russia and Ukraine and the subsequent supply chain disruptions have pushed up the price of crude and a $10/bbl rise in crude oil prices pushes India’s current account deficit by 0.5% of the GDP.
Exports get cheaper: When a domestic currency depreciates, its exports will become cheaper as exporters will get more rupee against the foreign currency. In short, industries linked to exports like pharma and IT benefit with depreciation, whereas those industries linked to imports have to bear higher input cost, which is ultimately passed on to the end users.
“A weaker rupee directly impacts India’s trade balance and inflation through higher cost of imports. Since February this year, a steeper decline in rupee coupled with the sharp rise in the commodity prices has led to a surge in India’s import bill. While a depreciating rupee also benefits exports, this is clearly being offset by the rise in the import bill. The trade balance has worsened from $73 billion in the first half of 2021, to $124 billion in the first half of 2022. Meanwhile, costlier imports are pushing up inflation domestically. In the consumer price inflation, this is directly seeping in through higher prices of fuel and imported food components such as edible oils, and indirectly via higher cost of inputs which manufacturers are rapidly passing on. Manufacturers, meanwhile, have been facing a higher pressure from imported inflation. Our analysis suggests that import price inflation accounts for about 60% of the wholesale price inflation today, compared to 28% in the pre-pandemic period,” said Dipti Deshpande, Principal Economist, CRISIL.
Current account deficit widens
Since India imports more than 80 per cent of its oil needs, a depreciating rupee will bloat the current account deficit (CAD) — a trade measurement where a country’s imports of goods and services exceed its exports. When CAD widens, India has to dip into its foreign exchange reserves to finance this deficit in the absence of dollar inflows by foreign investors into the country.
“India’s CAD is largely influenced by the merchandise trade deficit. This is expected to widen, as imports increase more than exports. Elevated commodity prices will have the largest bearing on import values particularly, crude oil. Crude and petroleum products are India’s largest import items, accounting for 27% of total imports.Further, import demand is sticky.. Thus, imports are expected to remain steady, despite high international prices and slowing domestic growth this fiscal. Exports, on the other hand, are highly sensitive to global demand — income elasticity of exports is high at 3.9. Since global demand is expected to soften this year (as recovery moderates, pandemic-induced policy support is withdrawn and monetary policy is tightened), India’s exports may not find much support. Further, we estimate the price elasticity of exports (i.e., responsiveness to prices; here, the real exchange rate) is low, at 0.8. Hence, a depreciation of the exchange rate may not provide much impulse to exports as global growth is the dominant driver,” explained Dharmakirti Joshi, chief economist at Crisil.
The Indian Rupee is edging closer to the 80-level mark after hitting record lows for consecutive sessions. Here is a look at the factors influencing the fall of the local currency and how it stands to affect the Indian economy and businesses
A blowout inflation print from the US and the prospect of a recession have analysts in a tense huddle over the Indian National Rupee’s (INR) descent. Analysts fear that a slowdown in the world’s biggest economy is bound to exacerbate the pressure from outflows. The Rupee has already fallen over 6.5% this year amid fears of a global recession and deteriorating external balances fuel outflows.