The ongoing Russia-Ukraine war and global factors including the US Federal Reserve’s interest rate increases will cause further depreciation of the rupee against the dollar, analytics company Crisil said in a report.
The rupee will likely be pressured by the widening of the current account deficit due to higher energy prices and the outflow of capital following US interest rate increases.
The Indian currency has already started reacting to external tensions and is likely to depreciate further and settle at about 77.5 to the dollar by March 2023, Crisil said in a report titled The Rupee Through Three Lenses, published on March 17. Since the outbreak of the war on February 24, the rupee has declined sharply.
“As of March 14, 2022, the rupee’s depreciation in the November 2021-March 2022 period was the sharpest relative to Asian and BRICS economies,” Crisil said in the report.
The rupee settled at 75.80 against the dollar on March 17, registering a rise of 41 paise over its previous close of 76.21, supported by positive domestic equities and broad dollar weakness.
One of the major factors that contributed significantly to the falling value of the rupee, according to the report, could be the withdrawal of funds amounting to $5.1 billion by foreign portfolio investors over the past few months due to risk-off sentiment arising from the Russia-Ukraine conflict and the tapering of global liquidity.
Factors including rising crude oil prices, the US Fed raising interest rates, and the intervention of the Reserve Bank of India to manage rupee volatility may have a worsening impact on the Indian currency in the future.
Oil imports
Following Russia’s invasion of Ukraine, Brent surged to $139.13 a barrel on March 8, its highest in 14 years, although it has since dropped to about $104 a barrel on March 17.
Alongside higher oil prices, demand for dollars to pay for oil imports has grown and this could affect the value of the rupee.
“India, being heavily reliant on imports of crude oil for its energy needs, faces a widening of the current account deficit next fiscal. Crisil expects the current account deficit to widen to 2.4 percent of GDP in fiscal 2023, compared with an estimated 1.6 percent in fiscal 2022 (with an assumption of crude oil at $85-90 per barrel for fiscal 2023),” it said in the report.
According to Crisil, with inflation in the US reaching a multi-decadal high of 7.9 percent on-year in February and the country banning imports of Russian energy products in March, there will be an increase in price pressure.
Moreover, reducing the interest rate differential between US assets and those in emerging economies will increase the relative attractiveness of US assets, leading to capital flows out of riskier assets of emerging markets. Consequently, there will be a fall in the demand for the domestic currency, leading to depreciating pressure.
The RBI’s initiatives to manage volatility in the Indian currency may have an adverse impact too.
“The central bank also conducted a dollar sell-buy swap of $5 billion on March 8, 2022, as part of its liquidity management measures, but this will also have an incidental impact on arresting the rupee’s slide,” Crisil said.
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