Multiple forces have been pulling the Indian rupee down, including the exit of foreign portfolio investors, the rising cost of international crude oil prices, and a strong dollar. Mint explains the implications of the decline in the Indian currency.
How low can the rupee go?
The rupee was falling till the middle of December 2021 over concerns about the economic fallout from the omicron wave, elevated crude oil prices, and expectations of quicker rate hikes by the US Fed. Subsequently, as covid cases declined, the currency showed signs of appreciation. The rupee came under pressure from late February in the wake of the war in Ukraine and the surge in crude oil prices. On 13 June, the rupee hit an all-time low of 78.29 to the dollar. Market participants expect it to trade in the range of 79-80 to a dollar going ahead, and touching 80 by the end of December.
What is the impact on inflation?
The Reserve Bank of India’s April monetary policy report made the assumption that the rupee will trade around 76 per dollar during FY23, adding that a 5% decline from this would raise inflation by 20 basis points. The rupee has already declined 2% from this assumption, signalling a worsening of inflation ahead. RBI said that given the high volatility in financial and commodity markets, the pass-through of currency weakness to inflation will not be linear and will vary with time. India’s inflation was earlier expected to moderate this year due to RBI’s measures, but the eroding rupee will deny this benefit.
What does a weaker rupee mean for businesses?
One, higher import costs. Second, Indian firms have been borrowing from the offshore dollar market, and the stock of commercial borrowing stood at $226.4 billion at the end of December 2021. Interest repayments are, therefore, expected to swell. Fund-raising through external commercial borrowing is likely to moderate too.
Will current account deficit worsen?
Current account deficit (CAD), or when the imports are more than exports, is expected to worsen. For a net importer like India, a weak currency isn’t good news. This worsens CAD especially at a time of heavy FPI outflows. The CAD could touch 3% of GDP (vs CAD of 1.2% in April-Dec 2021) due to higher import bills and a fall in forex reserves, since it is being used to finance the deficit. Forex reserves stood at $596.45 billion as on 10 June. However, over the next year, reserves could rise if exporters benefit from the cost advantage.
What are the options before RBI?
India’s central bank has been selling dollars from its reserves and buying rupee, which leads to the supply of dollar going up and that of the rupee falling.
At the beginning of October, one dollar was worth a little over ₹74 and it is currently around ₹78. If RBI hadn’t intervened, dollar could have touched ₹80 already. That said, RBI cannot keep selling dollars as its forex reserves will deplete at a faster pace. Since October last year, India’s forex reserves have fallen by around $40 billion.