Rupee’s woes not yet over; oil, Fed cues signal further fall towards 81 to dollar, say experts

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The rupee’s fall against the dollar may not be over as yet, given the wide range of negative cues stacked up against the local currency, experts said.

Elevated global crude oil prices, widening trade deficit, expectations of an aggressive US Federal Reserve and importer hedging further depreciating the rupee to as much as 81 per dollar in the medium term are feared to take the rupee further down, treasury officials and forex experts told Moneycontrol.

The rupee breached a psychologically important level of 80 per dollar on July 19 for the first time. The local unit hit an intra-day low of 80.06 a dollar, down from 79.98 at previous close, according to Bloomberg data. It opened at 79.99 and fell for the eighth consecutive session. In 2022, the rupee has lost 7.8 percent, with its downfall accentuating particularly after the Russia invasion of Ukraine in February. The local currency has depreciated nearly 6 percent in FY23.

“It is very unlikely that the rupee will gain materially from here. It keeps breaching key psychological levels, and that makes importers pretty active in hedging positions,” said Ashish Ranade, chief manager, forex and treasury, at The Cosmos Co-Operative Bank.

“Given a globally strong dollar and high inflationary expectations from the US, there is a thought that the Reserve Bank of India (RBI) may not want to offload forex reserves heavily and keep the rupee artificially higher,” he said.

Ranade expects the rupee to weaken to as much as 80.50 till July-end.

FPI outflows also worrying factor

The rupee is under pressure due to a record high trade deficit, coupled with persistent foreign portfolio investor outflows, which has pressured balance of payments. Add to that, the latest US inflation data for July.

It has reinforced policymakers’ support for another 75 basis points hike by the Fed when it meets July 26-27. The dollar index, which measures the greenback against a basket of six currencies, hit a high of 109.29 on July 14, a level last seen on October 21, 2002, according to Bloomberg data.

Further, oil prices have been volatile after Saudi Arabia declined to commit to output increases. Higher crude oil prices have the potential to widen trade deficits and add to price pressures in an economy like India’s, which imports nearly 85 percent of its crude oil needs.

RBI support crucial

The RBI, which intervenes in the forex market to control sharp movements, has apparently sold dollars from its forex kitty to keep the rupee’s depreciation under check, according to forex dealers. Amid persistent intervention from the RBI, India’s foreign exchange reserves plunged by $8 billion in the week ended July 8 to $580.25 billion, the lowest in more than 15 months.

According to forex market participants, the RBI will be present only to smoothen the volatility, and may not be aggressively present to stem the rupee’s fall at a time when other emerging market currencies are weakening. As per the latest RBI data, the rupee’s real effective exchange rate in June against a basket of 40 other currencies on a trade-weighted basis was 104.18. A real effective exchange rate of more than 100 indicates the rupee is overvalued.

Further, the RBI’s recently announced measures to boost forex inflows and alleviate pressure on the rupee’s exchange rate are unlikely to yield results, according to experts.

“The rupee is headed for a gradual depreciation since the RBI measures may not bring in massive inflows,” said Shreeshanth Arayangat, head, forex trading and merchant dealing, at DCB Bank. “Although the RBI is intervening in the market, it is not targeting any specific level.”

Arayangat expects the rupee to depreciate towards 80.50 in the absolute near term.

Market participants believe that, apart from intervening in the spot market, the RBI may have to introduce a swap window like it did in 2013, which will give more incentives to banks to get in more foreign deposits. In 2013, the RBI bore the risk in a swap scheme for banks. This had made mobilisation of leveraged Foreign Currency Non-Resident (Bank) deposits highly lucrative.

Further, it would be crucial for the RBI-led Monetary Policy Committee (MPC) to hike interest rates in line with the Fed to prevent further narrowing of the interest rate differential between the two countries and prevent further foreign outflows, experts said. The MPC’s next meeting is scheduled for Aug 2-4, while the Fed’s decision is due on July 27.

“The pivotal for rupee now (is) the RBI monetary policy outcome and the Fed’s decision. Rupee traders are now speculating whether the Fed will hike rates by 75 bps or 100 bps this month, and that should be a crucial factor for the MPC to watch out for,” said Arnob Biswas, head, of forex research, at SMC Global Securities. An ultra-hawkish RBI is a much-needed vaccine for the rupee to stand against the dollar heat during a quantitative tightening cycle.”

Also read: Banking Central | India fighting a losing battle on the rupee front

Currency hedging to accelerate

According to experts, currency hedging by importers and borrowers of overseas loans is likely to put further pressure on the rupee’s exchange rate. Through currency hedging, investors attempt to reduce the effects of currency fluctuations on investments. Since importers and overseas loan borrowers need dollars for making payments abroad, there is a tendency to hedge positions at current levels, assuming the rupee will depreciate further.

“Importers and those with dollar liabilities have been looking to hedge on dips (on the USD/INR pair). In fact, businesses have looked to pile up inventories given the uncertain supply-chain outlook,” said Abhishek Goenka, founder and chief executive officer at IFA Global, a forex advisory firm.

A lot of importers are hedging through long risk reversals, an options strategy that involves buying a call option and selling a put option. This strategy helps if rupee appreciates, added Goenka.

Anindya Banerjee, vice president, of currency derivatives and interest rate derivatives at Kotak Securities, had a similar view. Banerjee concurred that the pace of importer hedging has increased amidst a consistent rupee depreciation. Importers can continue to intervene as long as the rupee does not show a clear uptrend, he added.

Banerjee expects the rupee to fall to 80.50 over the medium term.

Limited downside beyond 81

Even though the rupee is poised to weaken further, some experts do not expect the currency to convincingly fall below 81 under the current circumstances.

“For one, the strength in the dollar index seems unsustainable at higher levels, with expectations that the European Central Bank and central banks in other developed markets will also hike interest rates aggressively,” said Sugandha Sachdeva, vice president – commodity and currency research at Religare Broking.

“The long-term inflation expectations have fallen in the US, and concerns of super-sized tightening by the US Fed at the forthcoming meeting have eased, which is leading to a retreat in the dollar index from multi-year highs and aiding the local unit,” she said.

“We do see some more pain for the domestic currency in the near term, but it is likely to remain cushioned by the 81 mark,” added Sachdeva. “The rupee-dollar exchange rate is expected to hover in the 78.50-81 band till September.”

IFA Global’s Goenka concurred with Sachdeva’s view and said that there could be a limited downside in the rupee’s exchange rate from here.

“Equity valuations are looking attractive, (while) the Fed’s communication is also aligned with market expectations. We do not see a lot of surprises from Fed henceforth,” said Goenka. We therefore expect the outflows from equities to moderate going forward. “Also, global crude prices may stabilise in the $90-to-$115 per barrel range.”

Goenka expects the rupee to trade in the 78-81.25 per dollar range over the next 8-10 weeks.