Explained: Why the rupee fell to an all-time low

The inability of countries like Japan and China to design their monetary policy to align with rising the US Federal Reserve rates has affected the value of their currencies and with other major Asian currencies performing poorly, the rupee was bound to be affected.

“There may not be an absolute correlation but if the Chinese currency is deteriorating, other Asian currencies may not react positively. The Chinese currency has depreciated much in the last few days as the People’s Bank of China (PBOC) has used the easy monetary policy system,” said Arnob Biswas, head of forex research, SMC Global.

But now, the effect of poor-performing Asian peers is visible on the rupee too. In the recent past, currencies like the Chinese yuan or Japanese yen have fallen drastically.

Like PBOC, Bank of Japan has fallen behind in tailoring its monetary policy to keep pace with global economic volatility.

According to experts, foreign exchange valuation works on monetary policy convergence or divergence. Whenever there is divergence, the currency is hit. 

The dollar’s strength

Forex traders and economists said that a rising dollar will continue to affect the global market. “The dollar index is gaining not just because of an aggressive Fed but also weak risk sentiment. There is a risk off in the market stemming from Ukraine-Russia crisis and tighter lockdowns in China. This is supporting demand for the safe haven, the US dollar,” said Swati Arora, economist, HDFC Bank.

There is also the possibility that the euro will fall to parity which will help the dollar remain the strong till the Fed’s rate hike cycle ends, say forex researchers.

Failed RBI interventions

Eight months after hitting a record high of $642.45 billion in September 2021, India’s foreign exchange reserves have now fallen below the $600-billion mark amid capital outflows and a strengthening dollar.

According to experts, the RBI has always tried to keep the value of the rupee on an even keel. “When rupee is weak, the RBI sells dollars to help recover the value and the RBI has been selling dollars quiet aggressively since March when oil started to go up,” said Anindya Banerjee, head of research for forex and interest rates, Kotak Securities.

Economists pointed out that due to the RBI’s interventions, the rupee has managed to remain stable so far, despite other Asian peers falling drastically against the dollar. But with the global economy facing several challenges, the rupee has felt the heat.

“From October 2021 till April 2022, foreign investment flows into the domestic equity markets have been negative,” said Kunal Sodhani, assistant vice-president, Shinhan Bank, Global Trading Center, forex and rates treasury. There were some inflows related to the Life Insurance Corporation of India initial public offering “but not enough to arrest the fall in rupee”, he added.

Although the RBI has intervened tin the forex market, doing so on a sustained basis is challenging. “FX reserves are likely to continue to fall with the trade deficit remaining elevated and amid foreign portfolio investment outflows. Revaluation losses (due to the dollar’s strength and rise in US Treasury yields) have also contributed to fall in FX,” said Gaura Sengupta, economist, IDFC Bank.

The RBI may now opt for a way to slow the pace of depreciation of the rupee, which has now turned an average performer, said the forex experts.

Weak risk sentiment

Be it the Russia-Ukraine crisis or China’s struggle with the Covid crisis, global events have played a big role in the rupee’s fall. “Global financial conditions are getting tightened which is weakening the euro and it created a negative sentiment in the market,” said Biswas. Arora added that foreign institutional investors’ outflows and weak risk sentiment have weighed on the dollar-rupee trade.

Rising crude oil prices

According to forex experts, hardening crude oil prices with the European Union moving ahead with imposing more sanctions on Russian oil are roiling sentiments, leading to worries about India’s widening current account deficit given its high energy import bill and exacerbating the pressure on the domestic currency. Sodhani added, “Higher Brent crude prices are also creating pressure on the rupee as it will have a direct impact on our fiscal deficit numbers.”

But experts have repeatedly pointed out that the RBI will go out of its way to ensure stability. “It (the rupee) seems poised to witness further depreciation towards the 78 mark in the near term. We however anticipate that RBI will intervene around the 78 mark to curb excessive depreciation in the Indian currency,” said Sugandha Sachdeva, vice-president, commodities and currency research at Religare Broking.

Future threats and implications

Despite its sudden fall, experts stressed that the rupee has been one of the best-performing currencies for the last one year. “More than the immediate impact, over a period of time the INR depreciation is likely to support exports. The balance of payments is expected to be negative in FY23, which will reduce the liquidity overhang in the banking system,” said Sengupta.