Rupee: A Storm in the Offing?

 

The US Federal Reserve’s aggressive campaign against inflation—hiking interest rates by 75 bps to 1.75%, the biggest increase since 1994—has boosted the dollar. Over it, the Fed has also cut its outlook for 2022’s economic growth: now predicting a 1.7% gain in GDP as against the 2.8% forecast in March. When a country raises its interest rates, the yield on debt issued in its currency obviously rises as well—a key factor behind the current surge in the dollar value. 

Coupled with the fear of recession spreading across the currency markets, the dollar has simply soared. As a result, the US dollar index—a measure of the value of the dollar against a basket of six foreign currencies, namely, the euro, Swiss franc, Japanese yen, Canadian dollar, British pound, and Swedish krona—has recently surpassed its 20-year high and is currently trading at over 106. 

This, coupled with the continuous rise in natural gas prices as a sequel to the ongoing Russia-Ukraine war, and the traders’ worry over the European Central Bank’s weakened effort to fight inflation, led to the fall of the euro by 1.7% to $1.03, its weakest level against the dollar since 2002. 

In sync with these global developments, as FIIs, seeking the safety of dollar-backed securities, unwind their investments in the Indian stock market, the rupee is fast losing its value: it plunged to its lifetime low of 79.28 to the US dollar on July 6.  Traders opine that had the Reserve Bank of India (RBI) not intervened timely by way of selling dollars in the form of derivatives and spot market interventions, the pace and intensity of depreciation could have been still worse. Yet, many analysts and traders expect the rupee to depreciate further to ₹82 a dollar in the coming months.

Of course, it is not the rupee alone that faced this reversal, several other Asian currencies, including the Chinese yuan, fared even worse.  But India has much to worry about, for the rupee has been declining steadily all through the year, losing as much as 6% against the dollar in 2022. And there is also a belief in the market that India’s forex reserves have depleted by more than $50 bn—dropped to below $600 bn from an all-time high of $642 bn—owing to the RBI’s market intervention operations to support the rupee, while officially it is explained as a consequence of the drop in the dollar value of assets held by the central bank. 

That aside, according to the estimates of the Ministry of Commerce and Industry, India’s merchandise trade deficit hit a fresh high of $25.6 bn in June, that too, in a row for the second month. Indeed, our international trade is facing a double whammy: on one hand, exports are sliding and on the other imports have surged by over 51% to $63.6 bn in June, more owing to the rise in global oil prices. As imports are crossing the $60 bn mark continuously for the last four months and the weakening rupee is all set to raise import costs further, there appears to be no scope for exports to rise in the foreseeable future as the growth in developed markets is expected to slow down drastically. So, it will not be surprising if the current account deficit, as expected by analysts, touches a ten-year high of 3.3% of GDP in the current financial year. All this, coupled with high domestic inflation is certain to hit rupee further down, challenging the wit of policymakers. 

In the wake of these adversities, the RBI has announced a slew of temporary measures—incremental NRE, FCNR(B) deposits exempted from CRR/SLR till November 4, allowed banks to raise NRE, FCNR(B) deposits without reference to regulations on interest rates, FPI investment norms regarding government bonds relaxed for new issuances of 7-year and 14-year maturity making them eligible for the fully accessible route, norms eased on residual maturity for FPI investments in government and corporate debt, limit under the automatic route for ECB increased to $1.5 bn along with a rise in the all-in cost by 100 bps— to augment forex inflows to protect the sliding rupee amidst the depleting forex reserves and also perhaps, to offset higher imported inflation. 

Now, the question is: Will they work in today’s integrated global financial market? There is no ‘the answer’ for, amidst the ongoing war between Russia and Ukraine, soaring oil prices, the looming threat of global recession, and more particularly, as most of the central banks are moving towards aggressive tightening of monetary policy nothing can be said for certain, except to wait and watch.