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After becoming Asia’s worst-performing currency in 2021, the Indian rupee has now touched a fresh all-time low of 79.11 against the US dollar on July 1. Rupee depreciation is showing worrying signs for the Indian economy, which is also dealing with high inflation.
The rupee has been sliding against the dollar since late last year, as a widening trade deficit and monetary policy divergence hurt its value. In 2022, the geopolitical tensions due to the Russia-Ukraine war, rising inflationary pressures and aggressive monetary policies from global central banks are hurting the currency. Indian equities have moved in tandem with the rupee’s fall, declining 9% in the first half of 2022.
Outlook for rupee depreciation
The Indian economy is taking cues from global factors, which have turned extremely negative in the past few weeks. The war in Ukraine put tremendous pressure on supply chain, causing a shortage food and energy in Asia. Crude oil prices are hovering at record highs as Russian oil is seeing fewer buyers.
India imports more than two-thirds of its crude oil requirement, and the high prices are contributing to inflation in the country. The Reserve Bank of India, to tackle rising prices, increased key interest rates by 90 basis points in a short span of time. This signalled the end of an ultra-loose policy and effectively slows down growth.
The aggressive rate hikes by central banks are being led by the US Federal Reserve, which Is seeing high inflation figures in the country. Recent data showed that consumer confidence in the US fell sharply in June anticipating weaker growth in the second half of 2022. The US Fed has indicated that it will aggressively raise interest rates in response to runaway inflation.
Steep rate hikes in the US have clouded the growth expectations, and market analysts now believe the US might be entering a recession. Ripples of the US recession will hit the Indian economy as well, Nomura said in a research note. “When combined with elevated levels of inflation that is eroding consumption growth and the growth sacrifice from tighter financial conditions, suggests a broader growth slowdown for India over the medium term,” wrote Nomura.
Meanwhile, rising US yields and an uncertain climate within the Indian economy have caused foreign investors to pull back sharply from Indian markets. Foreign portfolio investors (FPIs) have sold close to $26.6 bn worth of Indian equities during the first half of 2022. An exodus of foreign capital has further put pressure on the Indian rupee.
Coming back to the rate increases by the US Fed, the central bank is expected to hike rates by 75 basis points in July, whereas India’s next policy decision will come in August. The difference between yields is likely to put further pressure on the Indian rupee in the coming weeks.
India’s twin deficit and rupee depreciation
India is facing a terms-of-trade shock from higher commodity prices and weakening global growth, Goldman Sachs said in a note. “India’s external balances are deteriorating,” economists at Goldman wrote. “Going forward, the trajectory of the rupee is likely to be pushed weaker versus the dollar on account of the deteriorating external balances.”
India’s central bank is positive that economic risks are manageable, and the external sectors is “well-buffered to withstand the ongoing terms-of-trade shocks and portfolio outflows”. However, analysts are of the opinion that the Indian rupee will depreciate more than 80 by the end of the year.
A primary factor contributing to this rupee depreciation is India’s widening current account deficit which a Bloomberg survey predicts will widen to 2.9% of the GDP for FY22. “The broad-based increase in commodity prices is likely to keep the deficit sticky in the near term and, along with capital outflows, exacerbate the external financing requirements,” Rahul Bajoira, an economist with Barclays Plc told Bloomberg.
On the other hand, the country’s foreign reserves are declining fast as the central bank is selling dollars to stabilise the rupee, whereas importers are seeking more dollars to buy costly energy inputs.
In May, India’s trade deficit widened to an all-time high of $24 bn as the country’s import bull almost doubled due to record high crude oil prices. Exports from the country have slowed as the war in Ukraine and tighter monetary policies are weighing on growth and consumer demand.
To arrest the freefall of the rupee, India on Friday raised the import tax on gold and increased levies on exports of gasoline and diesel. While the Reserve Bank of India is trying to control the rupee’s decline, banks around the country are reporting dollar shortages as clients are rushing to swap the rupee.
However, investors stand to benefit after the rupee bottoms out as exports become competitive compared to other emerging markets. “Rupee depreciation attracts a lot of FIIs (foreign institutional investors) and boosts capital flows both via the FDI as well as the FPI route. Moreover, the trend shows that after every rupee depreciation cycle comes a period of a stock market rally,” Saurabh Goenka, CEO and managing director of treasury management firm Zenith FinCorp, told a local publication.
