The Indian rupee has plunged more than 6 per cent against the US dollar this year and tumbled to record lows against the American currency in recent weeks, weighed down by broad strength in the greenback and as investors retreated from domestic share markets.
The rupee hit a fresh low against the US dollar yesterday amidst continuing foreign portfolio outflows, rising oil prices, and a record trade deficit, leading to concerns over a wider current account deficit. The Indian rupee closed at a record low of 79.37 against the US dollar.
This is in spite of the Indian central bank’s conviction and actions to stall a freefall. The Reserve Bank of India (RBI) has attempted to save the vulnerable rupee. Most recently, the bank decided to sell US dollars. By selling US dollars, the bank is aiming to boost demand for the Indian rupee in the market and stabilize it in the coming months.
While the RBI maintained that it won’t let a runaway decline in the rupee take place, analysts predict that a fall to ₹81 a dollar is on the cards.
Since the war in Ukraine broke out in late February, the RBI has expended its foreign exchange reserves in order to shield the rupee from steep depreciation. Since February 25, the headline foreign exchange reserves have declined by USD 41 billion.
India’s June trade deficit widened to a record $25.63 billion from $9.61 billion a year ago amid a rise in crude oil and coal imports. The trade deficit widened as there has been a rise in imports after a surge in global crude and commodity prices following the Ukraine war, and rising demand for coal and other goods fuelled by the domestic economic recovery.
Forex reserves down $4.5 billion to $596.4 billion, shows RBI data. During the week ended June 10, the fall in the forex reserves was on account of a dip in Foreign Current Assets (FCAs), a major component of the overall reserves. Expressed in dollar terms, the FCAs include the effect of appreciation or depreciation of non-US units like the euro, pound and yen held in the foreign exchange reserves.
Nomura says, adding that the latest measures taken by the government on curbing gold imports by raising the import tax to 15 per cent and export tax on petroleum products may not help in reining in the widening trade gap.
Foreign brokerage Nomura cites, “weakening India BoP dynamics, aggressive Fed hikes and rising US recession risks,” to aim for the 82.00 level in the third quarter. Nomura expects the local currency to rise to 81 in the fourth quarter.
Dollar-rupee pullback remains elusive until the quote remains beyond the previous weekly range, between 79.10 and 78.85. That said, the 80.00 threshold lures the bulls. I don’t think ₹80 is a runaway depreciation by any metric. It’s a modest adjustment of a currency with deteriorating fundamentals.
Emerging market currencies have been falling against the dollar amid geopolitical tensions in the wake of the Russia-Ukraine war, concerns overgrowth, high global crude prices, sustained inflation and central banks worldwide adopting hawkish monetary policy approaches.
For many emerging markets, the strength of the dollar is a major challenge. The dollar is now at its strongest since the early 2000s, although the appreciation is most pronounced against currencies of advanced economies. So far, the rise appears mostly driven by fundamental forces such as tightening US monetary policy and the energy crisis.
What has triggered this fall in the rupee?
By some measures, the US dollar is at its strongest relative to the euro and yen in twenty years. As is often the case with market forces, that is good news for some and bad news for others. The dollar is strong right now for a few reasons.
After years of easy money, the Federal Reserve is raising interest rates. Higher interest rates mean higher returns for investors, and money goes where money grows. So that’s been bidding up the price of the dollar.
The dollar index has surged by almost 10 per cent this year due to the extremely hawkish actions by the Federal Reserve. In its bid to fight the soaring inflation, the Fed has hiked interest rates by more than 150 basis points this year. And analysts expect that the bank will boost rates by another 75 basis points this month.
The analysts say the dollar is likely going to remain strong for the next three months, possibly to the end of the year. The Fed wants to maintain a strong dollar so that the dollar can remain the world’s major reserve currency.
The Indian Rupee has been adversely affected mainly by the foreign institutional investors pulling out funds from the equity market, rising crude prices, the deteriorating trade balance and dollar strengthening. The Fed is expected to hike rates by 75 bps in the July meeting, while the RBI meeting is not due until August, which could narrow the yield differentials between India and US, and might further weigh down on the rupee.
Nomura Holdings has said there are increasing signs that the world economy is entering a “synchronised growth slowdown”, meaning countries can no longer rely on a rebound in exports for growth and have also “prompted us to forecast multiple recessions”. On the likelihood of a recession, US-based brokerage firm Goldman Sachs in its report has said it sees a 30 per cent probability of US entering a recession in the next year and a 25 per cent conditional probability in the second year if one is avoided in the first. Bank of America Securities also sees a roughly 40 per cent chance of a US recession next year, with inflation remaining persistently high. Federal Reserve Chair Jerome Powell says a US recession is a possibility, but not inevitable. Morgan Stanley economists expect a mild euro-area recession at the end of 2022.
Even as analysts are fearing of the US going into a recession in the next one year and the impact cascading globally, experts believe that the impact on India will be moderate and short-term. They say that the recession will pull down the prices of commodities globally, which can help the country sail through tough economic times. Also, India is majorly a domestic consumption economy, and as long as internal economic factors are positive, there won’t be any significant negative impact of a US recession in India.
As things stand right now, the Federal Reserve is by far the most hawkish major central bank in the world. In fact, it could cause the US dollar to be a bit of a wrecking ball against almost everything else, especially emerging market currencies.