The rupee may continue weakening against the US dollar and even test a fresh low as global stagflation fears are likely to cause a flight of capital from emerging economies including India, experts said.
Stagflation refers to a period of low economic growth combined with high unemployment and high prices.
The rupee, now at 77.55, closed at a record low of 77.73 to the dollar on May 19. This was the fifth time that the rupee had hit a record low during the month. The Indian currency has depreciated 1.5 percent vis-à-vis its US counterpart so far in May and is headed for its worst monthly fall since September.
The rupee’s troubles intensified of late as the appeal of the dollar has risen globally on worries of stagflation and aggressive interest rate hikes by the US Federal Reserve. Other emerging market currencies, too, have not been spared. The rupee has tumbled 4.3 percent so far in 2022, compared to a depreciation of 5.8 percent for the Chinese yuan and 7 percent for the Korean won.
“The overall bias for the rupee is skewed towards depreciation as global stagflation risks, relentless foreign outflows and a strong dollar index will continue to dominate,” said Sugandha Sachdeva, vice president, commodity and currency research, at Religare Broking. “Globally, fears of low growth and raging inflation are spooking sentiment against the backdrop of aggressive monetary tightening by the Fed.”
Foreign outflows from India’s equity and debt market have been “quite significant” of late, and if the trend continues, the rupee could depreciate towards 78.50 within two-to-three months, Sachdeva added.
Stagflation fears
Economists use three variables to measure stagflation–a country’s gross domestic product growth, unemployment, and inflation. When inflation remains stubbornly high and economic growth slows or becomes stagnant, it is referred to as a period of stagflation. Such periods can include high unemployment.
Globally, risks from the ongoing Russian-Ukraine war have increased worries over high inflation, which, in turn, hinders economic growth. Recent Covid-19 outbreaks in China and subsequent lockdowns have also dampened the growth outlook when central banks globally are hiking interest rates to quell rising price pressures.
Inflation rates are high in the US and the UK where supply chains have been disrupted and commodity prices are elevated.
The US consumer price index accelerated 8.3 percent in April, after accelerating to a 40-year high of 8.5 percent in March. The Fed, which targets inflation at 2 percent, raised its benchmark interest rate by half a percentage point at its latest policy meeting, shifting the target range from 0.75 percent to 1 percent. Fed officials have repeatedly signalled that more rate hikes are in the offing.
“The US economy is likely to slow; the Fed cannot bring down inflation without hurting growth,” said Anindya Banerjee, vice-president, currency derivatives and interest rate derivatives, at Kotak Securities. “Forex markets are pricing US interest rates to rise to 2.5 percent to 3 percent in the next 12 months and that will impact emerging market dollar inflows for some time.”
Foreign investors spooked
In such a situation, most investors typically prefer investing in safe-haven assets such as the dollar and gold and tend to shun emerging-market assets. When investor demand for dollars is high, its value increases. Subsequently, emerging market currencies pegged against the dollar, including the rupee, depreciate.
Foreign investors have pulled out a net $4.06 billion from the Indian equity market and $818 million from the country’s debt market so far in May, after withdrawing a net $2.24 billion and $579 million, respectively, in April, according to data from the National Securities Depository Ltd.
Foreign outflows accelerated after the RBI’s rate-setting Monetary Policy Committee hiked the repo rate by 40 basis points to 4.4 percent in an off-cycle meeting on May 4 amid worries of high domestic inflation. A 100 basis points is equal to one percentage point.
“It would take a long time for foreign investors’ appetite to return at a time when the interest rate differential between India and the US is on the rise,” said Sajal Gupta, senior vice president and head of forex and rates at Edelweiss Securities. “We do not rule out the possibility of the rupee falling to 79 to the dollar in the next few months.”
At least five forex market experts told Moneycontrol that the RBI has been selling dollars to stem the steep slide in the rupee and prevent volatility. This pattern is expected to continue.
“The RBI is managing the rupee’s slide and volatility quite well. The dip in forex reserves to below $600 billion also explains that,” said Arnob Biswas, head–forex research, at SMC Global. “However, it is inevitable that the rupee will head lower from here, especially as crude oil prices are expected to stay elevated.”
Biswas said there is a possibility of the rupee reaching 78.30 in the next few weeks.
Retail inflation
When the rupee depreciates, it loses its value. If the rupee’s value falls, imports become more expensive. India imports over 80 percent of its crude oil requirements. Higher crude oil prices hurt the country’s inflation trajectory as fuel, transport and food prices rise in tandem.
Retail inflation in India spiked to 7.79 percent in April and stayed above the RBI’s tolerance level for the fourth straight month. High inflation impacts India’s growth outlook and widens the country’s trade deficit.
According to Swati Arora, economist at HDFC Bank, a 1 percent depreciation in the rupee increases India’s inflation by about 5 basis points. Arora expects retail inflation to remain elevated, averaging above 7 percent in April-September.
Edelweiss Securities’ Gupta said with domestic inflation worries on the rise along with concerns over a wide trade deficit, the rupee’s problems are set to worsen.
“Since the RBI allowed the rupee to depreciate below 77 to the dollar, in line with global macro-conditions, we think that it is a signal that a gradual depreciation in the rupee is on the cards,” Gupta added.
