Is Depreciating Rupee Threatening

Rupee is Falling Against Dollar

The rupee has depreciated against the dollar from Rs. 68.63 on 27 June, 2018 to Rs. 68.79 on 28 June, 2018, after breaching the Rs. 69 mark earlier during the day. The rupee was supported by the RBI which intervened in the currency market by selling dollars. How threatening is the situation?

The drift in the foreign exchange rate is majorly powered by two sets of factors: fundamentals and sentiment.

Fundamental Reasons:

• Trade deficit: India’s trade deficit in dollar terms has increased from $ 13.2 billion in April’2017 to $ 13.7 billion in April’2018. This has been primarily on account of the rising crude oil prices which on an average was $53.8/barrel in April’2017 compared to $71.7/barrel in April’2018.
• FPI position: The net Foreign Portfolio Investment situation has discovered an outflow to the tune of $ 8.8 billion in the first three months of FY19 compared with a net FPI inflow of $12.2 billion in the corresponding period of FY18.
• Forex Reserve: The foreign exchange reserve has been depleting in the last three months and the reserve balance at the end of each of the respective months is provided in Table 1.

The net situation of balance of payments gets reflected in the changes in forex reserves which in turn affects the exchange rate.

Sentiment Led Factors

• Likely trade Wars: Increasing rifts between the world’s two largest economies- US and China on policies of hiking the tariff structure on certain commodities has kept the investors on the edge amidst fears of a global trade war.
• Increasing oil prices: Higher oil prices have also led to the fall in the rupee. While OPEC has agreed to increase output it does not compensate for the production cuts invoked earlier. To top it all there is talk of India having to substitute purchases from Iran with oil from other countries where payment would now be in dollars and not rupees. This has further pushed down the rupee. The Indian government has to take a decision on whether or not to follow the US in severing ties with Iran which includes moving imports of oil away to other nations. Iran is the third largest supplier to India and while such imports can be substituted from other countries, the benefit of rupee trade would no longer be available. But there is scope for negotiation with the USA.
• US Fed Rate Hike: The US Federal Reserve had raised the key interest rate for the second time in the fiscal; and there are growing expectations of further rate hikes (of at least 2) in this year following the latest statement by the Fed. However, RBI has narrowed the difference between the interest rates of the two currencies by hiking the interest rate in June’18. Higher rates in the US would slowdown the flow of funds to the emerging markets which in turn will affect the balance of payments.

The above reasons have driven the depreciation in the rupee which declined to a low of Rs 69 per dollar during the week – a market psychological level. However, this may not really be an alarming sign for the Indian currency when viewed against the background of what is happening to other currencies. Besides, the forex reserves are fairly comfortable presently to absorb temporary shocks.

How Have Other Currencies Fared?

Chart 1 presents the depreciation in various currencies against the dollar between end points of June 1 and June 28. It is not only the Indian rupee which is depreciating, but currencies of other countries like South Africa, South Korea, Thailand, Indonesia, China have weakened more than the Indian currency.

Chart 1: Change in exchange rate for the month of June’18

The chart shows that currencies of Indonesia, South Africa, Thailand, South Korea and China have decreased at higher rates between June 1 and June 28. Within the set of 12 currencies chosen here which have depreciated against the dollar, the decline in rupee was above the median value of 2.5%. Therefore, there has been a tendency for the rupee to also go with the flow as the dollar has strengthened.

The stronger dollar can be attributed to factors such as higher growth, lower unemployment, higher rates, fiscal spending by the government, lower taxes for corporate and the talk on curing unequal trade policies pursued by other countries.

Concluding Remarks:

• The above data points show that the weakening in the currency is not restricted to India but has been witnessed by many economies and a few of them have been impacted more than India.
• The foreign exchange rate will witness volatility due to the several pressure points covered above.
• However, in the current scenario, it is the sentiment driven reasons which are critical factors driving this weakness in the Indian currency. This prompted the RBI to intervene yesterday in the currency market through the sale of dollars.
• We believe that fundamentally the Indian rupee should hover around Rs. 68/dollar but will remain volatile – level will be driven by ‘sentiments’ around trade wars, sanctions on Iran, oil prices and the US Fed rate decisions. The rupee will be tested at every interval of Rs 1/$ i.e. at 69 or 70 and the market will look for direction from the RBI. Non-intervention by the RBI at each stage can take the rupee past 69 and towards 70 as long as the geo-political situation remains tense.