The Indian currency, unmindful of its committment to the economy, is touching new lows each day. Last week, it tore into 79 against the US dollar and now seems steadfast on cracking 80. The RBI, which has all the powers to lord over the exchange rate, is intervening prudently and is instead letting the rupee find a level of its liking. Perhaps, for now.
The one thing that’s weakening INR is higher demand for dollars. High imports led by soaring crude oil prices and sharp capital outflows (India being one of the worst among emerging Asian peers) are together raising the demand for dollars, depreciating rupee.
Since January, the domestic unit is down 5.6% against the greenback over last year, prompting the central bank to spare $41 billion out of its over $600-billion-odd forex reserves war chest it built in the past two years. But that move has sliced India’s import cover to single digits -- for the first time in three years. According to Barclays, RBI, under Governor Shaktikanta Das has a strong preference for currency stability and the ferocity of pressure on the currency can be seen from the fast depletion of forex reserves.
That said, allowing INR to gently weaken for now could be the right strategy, allowing the import-export imbalance, or the trade deficit, to improve. A weakening rupee boosts exports, though given the slack in global demand, exporters aren’t particularly enthused. Others believe, the central bank is letting the exchange rate adjust to new realiites, which in turn could act as a natural macro stabilizer.
Moreover, as Finance Minister Nirmala Sitharaman noted, the INR was relatively better placed than other global currencies against the greenback and pegged against other currencies, rupee is holding its ground, firmly.
For instance, last week, the Philippine peso slumped to its lowest level in over 16 years, while the South Korean won hit its lowest in nearly 13 years.
Several currencies have been facing sharp depreciation with the dollar index inching up an unusual 13% y-o-y. And amid rising inflation, concerns are beginning about the likelihood of ‘reverse currency wars.’
Agreed, INR’s fall is better among Asian peers, but given weakening portfolio outflows and deteriorating Balance of Payments, further rupee rout cannot be ruled out.
To address the ballooning Current Account Deficit (CAD), the government imposed higher duty on gold imports, besides new export levies on petroleum products, which are beneficial, though won’t materially alter the widening CAD, which is estimated to touch 3.5% of the GDP this fiscal.
As Barclays noted, little can be done about energy and commodity price shocks, but a much weaker currency complicates RBI’s job of managing inflation. Being a net commodity importer, India’s external balances remains vulnerable to higher global commodity prices.
“Typically, such episodes also see a surge of capital outflows, exacerbating the economy’s fault lines. With no easy solution in sight, we think the RBI has to either make peace with a weaker INR or continue on its path of depleting reserves to support the currency,” they concluded.
However, analysts at Emkay Global believe that India must respond with enhanced exports and reduced imports, otherwise a repeat of RBI currency buffers falling to 15% of GDP (a recipe for external instability, as seen during the 2013 taper tantrum) could throw up a challenge that nobody wants to fight.
The RBI has room to intervene now as against the previous rupee routs in 2013 and 2018. While 2013 saw an aggressive interest rate defense to protect INR from speculative positioning, 2018 saw a relatively shallow rate hike cycle.
The recent cycle has also seen the RBI now being vocal about protecting INR from speculative positioning and volatility.
The shortage of cash dollars and lower forward premia could pressurize spot INR and potentially lead to onshore-offshore arbitrage exploitation by foreign banks.
Thus, at some point, RBI would need to rethink its intervention strategy to correct this dislocation of premiums, they observed.
Allowing Rupee to gently weaken the right strategy
Allowing INR to gently weaken for now could be the right strategy, allowing the import-export imbalance, or the trade deficit, to improve.
A weakening rupee boosts exports, though given the slack in global demand, exporters aren’t particularly enthused.