By: Satyavan ‘Saurabh’
Rupee depreciation means that the rupee has become less valuable against the dollar. The Indian rupee fell to an all-time low of 77.44 against the US dollar. Tighter global monetary policy, strengthening of the US dollar and risk aversion, and higher current account deficit are a cause of concern for the Indian rupee.
Various factors are behind the depreciation of the Indian rupee, a sell-off in global equity markets triggered by an increase in interest rates by the US Federal Reserve (central bank), the war in Europe, and growth concerns due to Covid-19 in China. With the US Federal Reserve raising rates by 50 basis points, global markets were sold off as investors turned to the dollar. Dollar outflow is a result of higher crude oil prices and correction in equity markets is also causing adverse dollar inflows.
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In India, foreign portfolio investors have pulled out around $5.8 billion since the beginning of this financial year, according to Kotak data, adding to the pressure on the currency. The steps taken by the RBI to tighten monetary policy to counter rising inflation have also led to depreciation. The growing trade deficit is also under pressure – the deficit widened from $18.7 billion in March to $20 billion in April. In fact, according to analysts, the current account deficit is likely to remain at its highest level since the 2013 crisis.
The Indian rupee on Monday tumbled to a fresh low of 77.43 against the US dollar on a rise in crude oil prices, inflation fears, hike in interest rates and weak domestic equities weighed on investor sentiment. Risk aversion in global markets, the dollar’s strength influenced the demand for riskier assets, reducing the local unit. The rupee fell 0.7% to 77.43 against the greenback, having touched a previous all-time low of 76.98 in March this year. Analysts said concerns over the continued selling of Indian assets by foreign investors also weighed on the currency. The outlook on the rupee has deteriorated since Russia invaded Ukraine in February as global crude oil prices rose due to the conflict.
The impact of the rupee depreciation on the Indian economy will be far-reaching; the current account deficit is bound to widen, decrease forex reserves and weaken the rupee. With higher crude oil prices and other significant imports, the economy is heading towards cost inflation. Cost-push inflation also known as wage-push inflation; occurs when there is an increase (inflation) in aggregate prices due to an increase in wages and raw material costs. Companies may not be allowed to pass the high-cost burden entirely on to consumers, which, in turn, affects government dividend earnings, raising questions about the budgeted fiscal deficit.
A strong US currency, as well as pessimistic global market sentiment, is causing the rupee to depreciate. Market sentiment has also been hurt as investors are worried about rising inflation, tightening of monetary policy in major countries of the world, economic slowdown, and rising geopolitical tensions. Additionally, the broad trade bill, as the country imports 85% of its oil needs, has spooked investors. “Market participants fear that rising crude oil prices will hurt India’s trade and current account.
Rupee depreciation is a double-edged sword for RBI. A weaker rupee should in theory boost India’s exports, but in an environment of uncertainty and weak global demand, a fall in the external value of the rupee may not translate into higher exports. Inflation poses the risk of imported inflation and can make it difficult for the central bank to keep interest rates at record levels for long periods. India meets more than two-thirds of its domestic oil requirements through imports. India is one of the top importers of edible oils. A weak currency will further push up the prices of imported edible oil and lead to higher food inflation.
Curbing imports of non-essential items to counter depreciation would reduce the demand for dollars and boosting exports would help in increasing the flow of dollars into the country, thus helping in controlling the depreciation of the rupee. Masala bonds are directly linked to the Indian currency. If Indian borrowers issue more rupee masala bonds, this will increase liquidity in the market or increase the rupee stock against certain currencies in the market and this will help support the rupee.
External commercial borrowing (ECB) is a type of loan in foreign currency, made by non-resident lenders. Thus, easing of ECB conditions helps in getting more loans in foreign currencies, which will increase the inflow of foreign currency, which will lead to an appreciation of the rupee. The Reserve Bank of India is intervening to soften the currency’s slide – the fall in its forex reserves suggests it is a serious matter. It reduces the volatility of the currency.
Given that the rupee is overvalued, the central bank should allow the currency to slip, allowing it to find its level, only to intervene to reduce additional volatility. Currency depreciation will act as an automatic stabilizer. This will help ease the current account pressure by curbing imports, but more importantly, it will help boost exports, an important driver of the country’s economy at present. (The author is a Research Scholar, poet, independent journalist, and columnist, All India Radio and TV panellist)
