The rupee is likely to drift to fresh lows against the greenback in coming sessions as the dollar strengthens globally and on persistent capital outflows from Indian equity and debt markets, forex market experts and economists told Moneycontrol on Thursday, June 30.
Even though the Reserve Bank of India (RBI) is expected to step in regularly to limit the rupee’s volatility, a fall to 80 may be inevitable, said experts.
“The rupee’s move lower is in line with the underlying trend and what the fundamentals have been dictating recently. The dollar is still stronger during the current uncertain period on various counts like central bank policies, inflation, growth and geopolitics and that will not reverse in haste,” said Jayaram Krishnamurthy, co-founder and chief operating officer at Almus Risk Consulting.
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As per the technical analysis, the downtrend in the rupee is not over yet, Krishnamurthy said, adding that the currency could fall to 80.50 levels against the dollar in the medium term.
Why is the rupee falling?
The rupee depreciated 1.7 percent in June, taking its year-to-date decline to over 6 percent against the dollar. The currency closed at a record low of 78.9662 on June 29, according to Bloomberg data.
A dislocation in forward rates, persistently high commodity prices amid the Russia-Ukraine war and an aggressive rate hike cycle by the US Federal Reserve has strengthened the dollar globally and put emerging market currencies, including the rupee, under pressure. In its latest meeting, the Fed hiked interest rates by 75 basis points to tame inflation. The Fed is also scaling back pandemic-era liquidity surplus.
Besides, persistent foreign outflows from India’s equity and debt markets have weighed on the rupee. According to data from National Securities Depository Ltd, foreign investors have pulled out $23.4 billion from equities and $1.9 billion from debt so far in 2022.
“With no visibility of an early resolution of the Russia-Ukraine crisis, bids for the greenback could continue to remain supportive,” said Vivek Kumar, an economist at QuantEco Research.
“More importantly, the aggressive pivot displayed by the Federal Reserve would ensure that it remains the frontrunner among developed market central banks in addressing elevated and persistent inflation in the US amidst one of the strongest post-pandemic economic recoveries,” Kumar added.
Kumar expects the rupee to touch 81 against the dollar before the end of FY23. The RBI’s strong forex reserves and India’s attractive long-term economic potential would buffer any precipitous decline in the value of the currency, he added.
What does a weak rupee mean for the economy?
When the value of the rupee falls, it simply means that the dollar is more expensive and imports get costlier. Hence, a weakening rupee triggers imported inflation. A falling rupee also disrupts India’s trade deficit, which usually occurs when imports exceed exports. Widening trade deficits, in turn, widen the country’s current account deficit. Wild fluctuations in the rupee typically lead to the exit of foreign investors.
The root cause of the rupee’s distress can be found in elevated oil prices, as India meets almost 85 percent of its fuel needs through imports. The persistent snags in global supply chains, worsened by the war between Russia and Ukraine, have meant that prices of goods and services are likely to stay elevated, putting pressure on the rupee.
When the rupee weakens, it widens the country’s balance of payments deficit. The balance of payments position of a country is the net flow of dollars into the economy via current account and capital account transactions. As such, it becomes a crucial macroeconomic variable impacting the domestic currency.
Amid a steady depreciation in the rupee and rising oil prices, forex experts and economists have warned that India may be in for a wider balance of payments deficit for FY23.
QuantEco’s Kumar expects India’s net BoP deficit of $35 billion in FY23. As a ratio to gross domestic product, this would stand at 1 percent, the worst BoP position since the global financial crisis that saw a BoP deficit of 1.8 percent, added Kumar.
A weaker rupee could also widen India’s current account deficit (CAD). CAD occurs when the value of goods and services imported exceeds the value of exports. India’s CAD stood at $13.4 billion in January-March 2022, or 1.5 percent of GDP, according to the latest data.
“We expect CAD to widen further to 3 percent of GDP in FY23 largely due to higher commodity prices (resulting in a high import bill) and a slowdown in global growth, which is expected to weigh both on export and services growth,” said Swati Arora, economist at HDFC Bank. “A weaker rupee is likely to put further pressure on CAD.”
RBI response so far
Typically, the RBI intervenes in the currency market to trim volatility in the forex market. When the rupee weakens at a faster pace, the central bank usually sells dollars from its forex reserves via state-run banks in the spot market. The RBI’s forex reserves currently stand at $590.59 billion, the lowest since May 2021, against $632.74 billion at the start of the year.
Forex market participants said the RBI has intervened more in the forwards market of late than in the spot market to stem the rupee’s fall. Intervening in the forex market via forwards is liquidity neutral and helps conserving foreign exchange reserves.
RBI deputy governor Michael Patra had said on June 24 that the central bank will continue to stand for the rupee’s stability and will not allow any knee-jerk depreciation of the currency against the dollar.
“Technically, the RBI has to go with a lot of introspection before selling dollars,” said Arnob Biswas, head of forex research at SMC Global Securities. “We have seen during the earlier part of the Russia-Ukraine conflict, the RBI sold nearly $30 billion in March and April to defend the rupee and simultaneously keep forex reserves at $600 billion.”
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‘RBI intervention to continue’:
Forex market experts said the RBI will continue to defend the rupee to help importers and not allow a runaway depreciation in the rupee.
“The RBI has always been clear with no particular level in mind to defend. They want to contain excessive volatility and any sudden sharp depreciation of the rupee,” said Kunal Sodhani, AVP, Global Trading Center, Shinhan Bank India. “I think RBI will maintain their presence at regular intervals. Healthy forex reserves give the RBI an ammunition to intervene in the market and curtail excessive volatility.”
According to Madhavi Arora, lead economist at Emkay Global, the RBI should eventually let the exchange rate adjust to new realities, albeit in an orderly fashion, letting it act as a natural macro stabiliser to the policy reaction function.
“With our consumption-oriented imports being partly funded by hot money flows, a large currency overvaluation is not desirable for domestic output and employment creation,” added Emkay’s Arora.
