MUMBAI: The rupee has plumbed new lows, crossing the sensitive 92-mark to a dollar for the first time Wednesday, though likely central bank intervention curbed further losses in Asia's worst-performing currency for the second year on the trot. This came as the escalating Middle East war pummelled global markets and all other asset classes but set crude oil on fire having rallied more than 13% since Saturday.
The domestic equity markets closed with deep cuts for the second day with the indices losing over 3.25% each in just two days since the war began, while the benchmark 10-year bond yield rose 4 bps to 6.717%.
The rupee fell to 92.32, down about 0.91% or 72 paise in one of the largest single-day drops in recent months, eclipsing its previous record low of 91.98 hit in January. The rupee, which has lost more than 2.6% so far this year on the back of losing 4.9% in the previous year, opened 50 paise down from previous close of 91.68 and went on to lose more ground till the central bank intervened, preventing more losses and helping it close at 92.15—still a new record low.
And analysts don’t see this is the end but say the unit crossing the 93 level is not very far as the raging war and the resultant spike in crude have left investors scrambling towards safe-haven assets such as the dollar and gold, as the main pains for the rupee.
Sudeep Shah, head of technical and derivatives research at SBI Securities, told TNIE that the rupee is pressured mainly by the sharp rise in global crude prices amid escalating tensions in the Middle East.
“Higher oil prices increase our import bill, heighten inflation risks, and widen trade deficit, all of which weigh on the currency. Despite these challenges, a fall to 100 to a dollar appears unlikely,” Shah said, adding the RBI has a strong track record of intervening to curb excessive volatility and is expected to act decisively if the situation worsens. Therefore, while “the near-term weakness may persist, an extreme fall remains improbable.”
Alexandra Hermann, lead economist at Oxford Economics, and economist Yash Adwani, however, have a different view on the rupee pain.
“In addition to wider risk-off sentiment, concerns over rising inflation and a widening trade deficit, we believe the rupee’s slide has been exacerbated by increased speculative positioning on the limits of the RBI’s ability to defend the currency--similar to patterns in recent months. The fundamentals don’t justify the rupee’s current level of underperformance,” they said.
Though it’s true that the country imports 85% of the oil it uses, the economy itself is not extremely oil-intensive, they said further. “In electricity generation, oil is almost irrelevant: roughly three-quarters of electricity generation comes from coal, with most of the remainder coming from hydro and renewables. The broader energy picture tells a similar story. Oil accounts for only about a quarter of the country’s total primary energy consumption, a lower share than in much of emerging Asia.”
They further believe that “the near-term inflation impact will be limited. Retail fuel prices won’t move one-for-one with crude prices, with oil marketing companies margins absorbing of the shock, at least if the oil price spike isn’t sustained for a long period.”
However, they warned that the rupee may be in for more pain if the war lasts longer. “If the war goes on, chances are the rupee will end the month around 92.5. It could even temporarily cross the 93 mark depending on how the situation evolves, although we don’t think it’d stay above that level by month-end."
Sachin Sawrikar, founder and managing partner at Artha Bharat Investment Managers ISFC, said for foreign investors, currency volatility directly affects dollar-adjusted returns. If depreciation outpaces yield differentials, it may deter portfolio inflows and potentially trigger FPI outflows.
According to Tanay Dalal, senior vice-president–business & economic research at Axis Bank, “The Iran war has merely brought forward the currency moves we have been highlighting for some time. The rupee is undergoing a structural adjustment towards a weaker fair value, driven by sustained capital outflows and a shrinking pool of global savings rather than any single geopolitical event.”
Furthering his view, he said the rising defence-led fiscal spending globally is absorbing savings that were earlier available for investments, while capital flows are once again being priced with a geopolitical risk premium. As a result, the REER value of the rupee is gradually reversing a part of its 2010s outperformance, with RBI intervention focused on smoothing volatility rather than resisting the underlying adjustment, as balance of payments dynamics move fair value closer to current levels.
"Remittances from the Middle East as well as capital flows are likely to get impacted in the scenario of an extended regional conflict," analysts at Kotak Mahindra Bank said, adding in case of an extended crisis, "the country’s macroeconomic outlook is expected to weaken through widening of current account deficit, higher inflation, sharper rupee depreciation and lower growth."
Abhishek Bisen, head of fixed income at Kotak Mahindra AMC, said the rupee has slipped to a near‑record low of 92.32 as the escalating Iran war has heightened fears of disruptions in the Strait of Hormuz and the resultant spike in crude prices, with Brent rising roughly 13%. All these have amplified macro risks for the country, given its near full dependency on oil imports.
“Higher crude prices threaten to widen the current account deficit and reinforce inflationary pressures, prompting the likelihood of RBI intervention to curb excessive volatility, although sentiment remains fragile amid concerns of potential portfolio outflows," he said.
"Even so, given that the rupee was already relatively weak on a REER basis, a disproportionate depreciation vs peer currencies appears unlikely. Much of the current weakness reflects markets pricing in a high probability of further geopolitical escalation; therefore, if tensions fail to intensify, crude prices are likely to ease and the rupee to regain strength," he added.
Four days into the conflict, both Israeli and US forces have intensified strikes across Iran. In response, Iran has launched retaliatory drone attacks on US missions in the Gulf. As a result, the Strait of Hormuz has been shut off, choking a crucial passage of oil towards major economies. Nearly 40% of our energy imports pass through the Strait.
Elevated Brent crude prices are detrimental to the rupee, as they will lead to a higher import bill, and therefore lead to a wider current account deficit. Although it may not be immediate, a potential rise towards $100 a barrel in the near-term will likely cause more damage to the rupee’s prospects.