Wednesday, Jul 06, 2022
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From Import Bills To Inflation, A Plunging Rupee Spells Doom For Indian Economy

While cheers are emanating from India’s export camp, which earns in dollars, it is a rather gloomy sight for the importers and, in turn, the households 

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The Indian rupee on Wednesday fell to an all-time low of 77.58 against the US dollar following the strengthening of the American currency and continuous selling by foreign institutional investors (FIIs) in the Indian equity market. 

A surge in international crude oil prices is also being seen as one of the factors behind the rupee's downward spiral. Expensive crude oil coupled with strengthening dollar leads to higher current account deficit, a cause for concern for India from an economic perspective, say analysts.

Falling Rupee, Rising Import Bills, Inflation

Foreign trade is one of the spaces that is directly affected by the depreciation of the rupee. While cheers are emanating from the export camp, which earns in dollars, it is a rather gloomy sight for the importers and, in turn, the Indian households. 

A falling rupee leads to an increase in the cost of imports, putting extra pressure on people’s pockets in the country which has an import-oriented economy. 

Wholesale Price Index in India has been in double digits for 12 months, with March numbers reported at 14.55 per cent. Higher inflation has forced RBI to hike interest rates for the first time since August, 2018. The move is set to make cost of capital expensive in India, making EMIs for home loans and other items expensive.

But exporters are happy. India's exports rose by 24.22 per cent to touch a record high of $38.19 billion in April on the back of healthy performance by petroleum products, electronic goods and chemicals.

But the uptick in exports has not helped India in managing trade deficit, which widened to $20 billion in April, as compared to $15.29 billion in the same month last year. India's current account deficit for the current financial year is expected to be to 2.6 per cent of GDP in 2022-23 from 1.7 per cent of GDP this year, Nomura said in a report last month.

A weaker rupee will increase the country's import bill as a rise in the price of India's main import item—crude oil—will expand the country's current account deficit, says Sandeep Bagla, CEO, Trust AMC. To meet its demand, India imports 85 per cent of the crude oil needed. 

"Emerging market currencies have depreciated sharply against the US dollar in the last few weeks. Comparatively, the Indian rupee was stable and has recently depreciated to new lows. It has a negative impact on both the economy and the markets. Our imports become expensive, putting pressure on the current account deficit. Weak currency puts pressure on domestic inflation due to higher import prices," Bagla explains.

Exit Cue For FIIs

The dollar’s current strength can be attributed to the safe-haven demand amid geopolitical tensions and a reversal in the interest rate cycle in the US. The rise in interest rates in the US has, in turn, led to selling by FIIs in the Indian equity market, stocking fears of a bear market. It can start a vicious cycle of rupee's depreciation which will further lead to high inflation in the economy, forcing RBI to increase interest rates.

This year, the foreign investors have so far sold shares worth Rs 1.38 lakh crore, showed data from the National Securities Depository Limited.

“Stronger dollar and the sustained moving up of the global crude oil price are weighing on the overall market sentiment. This week, the focus will be on the inflation numbers that will be released on the domestic front as well as from the US. We expect the USD-INR (Spot) to trade with a positive bias and quote in the range of 77.20 and 77.80,” says Gaurang Somaiya, forex and bullion analyst, Motilal Oswal Financial Services.

Amit Pabari, MD of CR Forex Advisors, says that the USD-INR pair is expected to move higher—towards 78-78.50 over the short term (1 to 3-month perspective) and towards 79 over the medium term (3 to 5-month perspective). “On the contrary, a breakout point in the 76.95 to 77.10 zone will act as crucial support,” Pabari adds.

Silver Lining 

Santosh Meena, head of research at Swastika Investmart, however, is confident about the rupee’s might, stating that it is still amongst the best-performing emerging market currencies despite its recent fall. He says that while the FIIs have sold almost Rs 3 lakh crore in the Indian equity market since October 2021, the rupee has remained resilient because of high forex reserves that will provide enough ammunition to the RBI to intervene. 

In 2013, when, rupee went into tailspin after then Fed Chair Ben Bernanke announced that it would phase out asset purchase programme, the Reserve Bank of India responded with a range of policy measures to stem the rupee fall. The RBI tightened monetary policy by increasing the cash reserve ratio (CRR) and also imposed restrictions on imports of gold. 

Then RBI Governor Raghuram Rajan also launched FCNR-B scheme discounted currency swaps to banks to regulate inflow. Through this, banks raised whopping $25 billion through FCNR deposits and $9 billion through foreign currency borrowings, which helped rupee from falling further.

“The rate hikes throughout the world will cool off the prices of major commodities and supply chains will normalise, capping the further rise in inflation. This will moderate the further depreciation of the rupee,” Meena explains, adding that he believes the RBI will intervene in case of too much fall in the rupee.
 

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