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Rupee near 78: Four ways a weak currency impacts the Indian economy

Banks, especially public sector lenders, that have actively raised money from offshore markets will find it costlier to service debt due to the currency’s depreciation.

May 12, 2022 / 07:17 PM IST
Representative image

Representative image

India’s rupee is in a free fall. At the interbank foreign exchange, the rupee opened at 77.46 against the dollar on May 12 and has depreciated over 1.2 percent this month.

Global geopolitical tensions and the subsequent rise in inflation and oil prices are the key reasons for the rupee’s depreciation, experts said. Through this explainer, Moneycontrol lists four ways a weak currency can impact the Indian economy:

Wider current account deficit

The current account deficit is the shortfall between the money a country receives by selling domestic products to other countries and the money it spends to buy goods and services from other nations. If the value of the imported goods and services exceeds the value of the exports, the country is said to be in a deficit.

India’s current account deficit widened to $23 billion, or 2.7 percent of GDP, in October-December 2021 from $9.9 billion in July-September 2021 due to a higher merchandise import bill. Analysts said the gap is likely to widen further.

“We are facing multiple challenges – high oil prices, retail prices are the highest. And with a weak rupee, the adversities will only increase. Firstly, the current account deficit in rupee terms will be much more impacted,” said Soumyajit Niyogi, director of India Ratings & Research. “Data suggests that import activity is still very resilient and the rupee’s fall will impact it. Importantly, in uncertain times, people have more faith in gold, so gold import is another cause for concern. In a nutshell, the entire current account deficit including gold will go up faster due to the rupee depreciation.”

Debt servicing

The ability of companies and banks to service debt will become strained as the rupee depreciates. Banks, especially public sector lenders, have been actively raising money from offshore markets via additional tier-I bonds and will find it costlier to service the debt due to the currency’s depreciation.

“If you are a corporate and have borrowed money and must service debt, you will need more rupees to trade the same amount of dollars. If your earnings are in rupees, it becomes difficult to service debt,” said DK Joshi, chief economist at CRISIL.

The positive side of a weaker currency is that it benefits the export sector because products and services will be cheaper for foreigners. However, weakening global demand will likely offset this positive aspect, Joshi said.

“So overall, exports are unlikely to benefit,” he said.

RBI steps to curb depreciation

The Reserve Bank of India is already intervening in all forex markets and will continue to do so to protect the rupee, Bloomberg reported on Monday, citing a person familiar with the matter.

The RBI intervened in the spot, forward and non-deliverable forward markets on Monday, the person said, adding that the RBI sees pressure on the rupee from a weaker yuan and stronger dollar, rather than domestic reasons.

Joshi said the rupee had depreciated sharply during the 2013 taper tantrum, too. Then RBI governor Raghuram Rajan had launched a special window to swap foreign currency non-resident (FCNR) dollar funds to boost foreign fund inflows.

However, the present situation is not as dire as in 2013 because there is a stronger shield in the form of about $600 billion in forex reserves. But the shock from the US Federal Reserve is much bigger this time with a series of rate hikes expected in 2022, Joshi said.

“In this situation, the RBI cannot influence the direction of the currency. It can certainly check the speed at which the rupee depreciates. The RBI has deployed monetary tools (interest rate hike) and interventions in the forex markets to stabilise the currency,” he added.

Niyogi of India Ratings has similar views. According to him, the central bank can control volatility in the forex market by intervening through commercial banks by doing buy-sell swaps and dipping into forex reserves.

Lower purchasing power

Depreciation of the rupee will cause a fall in purchasing power.

For exporters and students and travellers heading overseas, the fall in the rupee will mean rejigging their expenses, which will likely dent demand.

“When the rupee is losing value, buying an asset abroad in the Indian currency will be expensive. Education and holidays in foreign countries also turn more expensive,” said Kunal Sodhani, assistant vice president at Shinhan Bank. “A weak rupee affects corporates who might have raised debt abroad and have partially or not hedged their positions. It also decreases the purchasing power of the nation.”
Moneycontrol News
first published: May 12, 2022 07:17 pm