As rupee falls, how long can RBI keep on defending it?
The Indian currency is facing one of the toughest fights of its life. In the crosshairs of a triple-barrelled gun of capital outflows, higher crude oil prices and widening Current Account Deficit (CAD), the domestic unit yet again hit a new low of 78.29 against the US dollar on Wednesday.
So far this year, the rupee has fallen about 5%, while the dollar index—pegged to a basket of six currencies—has shot up 10%. Attracted by higher interest rates in the US, investors are selling rupee-based investments in favour of the greenback, weakening the Indian currency. The RBI believes there is a 5% chance that portfolio outflows could be 3.2% of GDP or $100.6 billion a year, which incidentally is a similar amount of forex accumulation at $105 billion in FY21. Till date, FPIs have sold $29 billion worth assets in 2022 and if the trend continues, it will be troublesome.
In contrast, the US dollar index hit a two-decade high of 104.507 and continues to gain, but every such increase weakens not just the rupee but almost every other currency, in any case under pressure from soaring energy prices. The worst hit among them is the Japanese yen that sunk to a 24-year low against the dollar. Likewise, the Korean won, Turkish lira and even the Chinese yuan were not spared. In May, the rupee depreciated by 1.5%, but as per the RBI, the depreciation was rather modest.
While the rupee is one of the worst-performing Asian currencies in nominal terms—losing 4% against the dollar since the start of the Russia-Ukraine crisis—we were better off than others like the Bangladeshi taka that fell 8.2% since the crisis, or the Chinese yuan and the South African rand that depreciated 5.7% and 5%, respectively. On its part, the RBI is defending the rupee, selling forex reserves, sucking out rupee liquidity and helping contain imported inflation for now, but this cannot go on for long as it affects our competitiveness. Currency management is a tricky issue and the RBI must strike a balance.