Beneath rouble’s rubble, rupee gets a collateral damage

The rupee has depreciated more than 2 percent since Russia invaded Ukraine on February 24 and the Indian currency is likely to continue to be under pressure due to the ongoing geopolitical conflict.

Last week, more sanctions were imposed on Russia and its rouble has already sunk almost 20 percent against the dollar, which made the country’s central bank hike policy rates sharply. The conflict has triggered a widespread rush to the safety of the dollar and that has meant most emerging market currencies have depreciated.

The rupee too is in the same camp. During crises, foreign funds typically tend to avoid investing in most emerging market economies as a block even though some countries may be more resilient than others. Indeed, the rupee’s weakness stems from the broader and democratic rise of the dollar against most currencies.

The US dollar has gained sharply against a basket of currencies ever since Russia’s aggression against Ukraine escalated. The dollar index has risen about 1.4 percent in the past one week. Other emerging market currencies such as the Indonesian rupiah, Philippine peso, South African Rand and Brazilian real have all lost 0.5-2 percent since Russia’s invasion of Ukraine.

Where to now?

Depreciation pressure on the rupee is expected to continue. Two big reasons for this are rupee assets belonging to the riskier emerging market basket and India being a net oil importer.

Analysts at Nomura said the Indian rupee and the Philippine peso will face the most pressure in the ongoing crisis.

“We believe that, because of relatively high net oil imports (% of total trade), the more vulnerable currencies include INR, PHP and THB. India also stands out, as its average monthly petroleum trade deficit over the six months to December 2021 was $8.2bn, or close to 50 percent of its average trade deficit of $17.6bn over the same period,” they wrote in a February 24 note.

The exchange rate’s weakness lies in the fact that India is a net importer of crude oil, the price of which has surged globally. A higher import bill would mean a wider current account deficit than anticipated and the balance would tip against the exchange rate. Analysts said India’s current account deficit would widen to 2-2.5 percent of gross domestic product for FY22 and even further for FY23 due to the oil price surge.

Beyond this collateral damage, the rupee’s fortunes may not turn dire. The expectations are that the rupee may weaken to 77 to a dollar from current levels, implying depreciation of about 2.5 percent. In essence, the currency’s path from here would be more stable. But for this to happen, the forex market is counting on the Reserve Bank of India. Indeed, a foreign exchange reserve pile of over $633 billion amassed by the central bank has been highlighted as strong support for the rupee time and again.

This means that the RBI’s interventions are likely to remain significant going forward. The central bank has already created some room for it through a sell-buy swap of two-year tenure worth $5 billion with market participants. Through this swap, the central bank will sell dollars immediately but buy them back two years hence.