Global currency markets witness values constantly moving up or down based on the demand for the currencies. The Indian Rupee was one of the resilient currencies in the world till the beginning of 2018. Since 2018, it has tumbled about 6 per cent in value against the US dollar.
A sharp fall like this tells a story. This story is available for you to see in the Reserve Bank of India’s Balance of Payment statement released last week. There are strings of data that you need to interpret.
A currency of an economy weakens when it owes more money in foreign exchange than what it earns. This is called the current account deficit. India’s current account deficit rose to 1.9 per cent in the quarter to March 2018. It was 0.6 per cent in the same period last year.
This means India owes more money in foreign exchange than before. A key reason for this is the sharp 11 per cent rise in oil prices in the March 2018 quarter over the preceding December 2017 quarter. This resulted in a high trade deficit, which means India’s imports soared and exports slowed.
No immediate change likely
The US economy is showing a strong growth and the US Federal Reserve — the central bank that sets interest rates — hiked borrowing rates by 0.25 per cent. In the outlook, experts have mentioned that there could be two such rates in 2018.
In addition, the trade war initiated by US president Donald Trump with key partners is likely to push inflation higher in the US economy. This is perhaps one of the prime reasons why interest rates would remain elevated in the US. The US government is also keen to reduce the trade deficit and effectively the current account deficit. This could further strengthen the US dollar.
High-interest rates in the US means less risk appetite. Most investors prefer putting money in savings or fixed income accounts than investing in high-risk markets. Emerging markets witness a sell-off when US interest rates remain high.
This is a huge setback for emerging markets like India that rely on foreign portfolio investment flows. Lower foreign fund flow would mean further risk to the Rupee value in future.
Oil prices are expected to remain high and there are no signs of the oil-producing countries looking to increase production. The relentless demand for fuel in India means the overall oil import bill would be higher in the coming months.
What could you do
On the ground, you could have felt inflation. In fact, consumer price inflation rose to 4.87 per cent in May 2018 against 4.58 per cent in April 2018. A similar trend was seen in the wholesale price inflation. A weak rupee is a contributor to the rise in the inflationary trend.
The impact of this is a rise in your borrowing rates on loans. The Reserve Bank of India watches inflation like a hawk. It is keen to set India’s long-term inflation around 4 per cent. If it stays high, there is little chance of borrowing rates to fall quickly.
It is not all bad news though. A strong US economy and a US dollar mean good news for Indian exporters. Companies in the software services and pharmaceutical industry have been looking for a revival in demand for their services and products respectively.
They also get a tailwind push with the US dollar surge, as over two-thirds of their income is generated in the US. Over the past one month, the NSE Nifty is flat. However, the NSE Pharma index is up 10.5 per cent and NSE IT index is up 3 per cent. Overall, the IT benchmark has gained close to 20 per cent in value in 2018 in comparison to overall flat trend in other sectors.
Share prices of companies are unlikely to rally too. Inflows from Systematic Investment Plan (SIP) investments in mutual funds are holding share prices in India steady. Foreign Institutional Investors’ (FII) money flow dropped in March 2018 by two-thirds in comparison to the year-ago period.
Considering the rising interest rates in the US, FIIs are unlikely to pump money in large quantities in emerging markets like India. Considering the balance of flows, Indian shares are unlikely to fall sharply or rally sharply till May 2019. This may be a good time to enter markets through SIP plans in equity-linked mutual funds or balanced funds. Your financial advisor will guide you to the right allocation.