The Indian rupee crossed the psychological barrier of 80 to a US dollar on Tuesday in trading on foreign exchange markets. On Wednesday, it recovered a wee bit. Now, it is becoming exciting to track how the rupee is fending for itself in the markets and whether it should recover some lost grounds. Following the economic reforms and liberalisation, the overseas investment norms were revised and foreign institutional investors were allowed to put their money in Indian stocks. While that is good as it brings in a lot of investment dollars, there are some downside risks as well. If you are allowing overseas investment in secondary markets, it brings in the risks of withdrawals of overseas secondary investment in Indian stocks when the financial markets are in trouble. We have seen this happening in the wake of the global financial meltdown. This is exactly what is happening now. Because of the knee-jerk reactions to oil prices due to uncertainties from the Ukraine war, rising inflation across the world, and disruptions of normal trade channels, the central banks are recasting their monetary policies.
In expectation of future hikes in US interest rates, overseas investors in Indian stocks are withdrawing. Reports indicate that foreign investors have withdrawn some USD 30 billion this year. On top, they are further feared to withdraw money to keep their investable funds for future investment in dollar assets. As a result, these investors are withdrawing from all other markets and are pouring funds into US markets.
Consequence? The US dollar is appreciating and all other currencies are depreciating, the Indian rupee is only one of them. It may be mentioned that the European Union’s common currency, the Euro, has also depreciated against the dollar and is now plumbing to unprecedented depths. The question that now crops up is what value the Indian rupee will reach in the immediate future against the US dollar. Past experience could be useful to project the future. The sharpest depreciation of the Indian rupee took place between 2010-11 and 2015-16. At the beginning of this period, in 2010-11 the rupee was 45.56 to the dollar. This went down to 65.46 to a dollar in 2015-16. That is a side of INR 20 in just about five years.
It may be recalled these were the period of what has come to be known as ‘Taper Tantrums’. The US Fed had embarked upon a huge bond-buying spree, now as ‘Quantitative Easing’ after the global financial meltdown in 2008-09. The Fed chairman, Ben Bernanke, had announced his plan to reverse this and start winding down the bond purchase program. This would mean that less money would be available. The talks set off a massive shuffling of investments in the financial markets. The major investors started withdrawing from the emerging market economies and concentrating on the US. What is worrisome is, however, that the Reserve Bank is intervening in the market to shore up the rupee. This might only blow up India’s foreign exchange reserves and ultimately achieve nothing. The rupee can still depreciate even after RBI spends a lot of dollars to defend the rupee. True the rupee depreciation will impose heavy costs on the economy. But it is better to see through these tribulations than try to artificially shore up the rupee in a dog fight with the financial markets.
