Indian rupee continues to hog the limelight for a variety of reasons. First, it is now the worst performer among Asian currencies this year, having depreciated nearly 11 percent this calendar year and looks poised to remain weaker for some more time.
Analysts and economists are also debating if this sustained weakness is a boon or a bane and the jury is still out. The protagonists for a weaker rupee argue that on a trade-weighted basis the Indian rupee is still overvalued and therefore the current levels (70 to a dollar) should not be a concern.
And a weaker rupee helps us to increase our exports, thus helping to reduce CAD and provides us with a competitive edge in global trade.
However, the antagonists may feel this weakness would exacerbate the trade deficit as India is a net importer. A weaker rupee will also end up importing inflation via crude and other consumables.
While there is merit in both arguments, the realities lie somewhere between the two extremes. The current weakness has been triggered mainly by a few external events.
First, the collapse of Turkish lira and its cascading impact on European banks threatens to become a contagion. Emerging markets felt the tremours as domestic assets in these countries sold off and currency repatriation followed. Argentina panicked and hiked rates sharply.
Second, crude prices first rose sharply and have been consolidating at higher levels for many months now. Oil companies, therefore, have been buying more dollars than they would normally have.
Third, US rate hikes and prospects of further hikes have been exerting pressure on domestic debt markets as foreign investors look to exit this category of the asset class.
Fourth, the trade war between the US and its major trading partners is turning out to have a secondary effect among emerging markets via currency weakness and protectionist reactions. The combined effect of these has been a sharp weakness in the Indian rupee.
If one places in perspective the current weakness of rupee among its peers and also in a larger basket of emerging market currencies, the Indian rupee has weakened far in excess, by more than 2 percent in August alone, whereas the average depreciation of major Asian currencies has been less than three-fourths of a percent. Let us examine the fundamental factors.
Trade balance for July was a major cause of concern as the trade deficit widened to USD 18.02 billion, up nearly 57 percent over corresponding last year.
While oil imports surged 57 percent, non-oil imports in Gold and Electronic goods also increased sharply. With festival season ahead, import of gold may remain higher and continue to exert pressure on the currency.
Looking ahead… the general reaction to rupee’s sharp weakness has been less strident and critical this time around in comparison to the past episodes. There is less panic, while importers have been rushing to cover, exporters are not showing urgency.
Maybe due to the impression that further weakness will be acceptable and barring interventions to smoothen volatility, the broader trend is towards further weakening.
The stock markets are in uncharted territories for a majority of the global indices. The US Dow, for instance, has been in a secular bull trend. Even a 10% correction could have a cascading effect here and should be another driver for the weaker rupee.
India’s short-term foreign debt is above 40% of total debt and matures within a year. Even assuming half of it is rolled over, the balance may need to be funded.
This is in addition to the trade deficit. Overall, in the shorter run, there may exist sustained pressure on the rupee.
The Government and RBI have a plethora of tools to prevent a sharp and abrupt depreciation, ranging from intervention, rate-hikes, CRR hikes, direct USD selling to oil companies, issuance of FC Bonds to restriction on certain classes of imports, forced-sale of EEFC deposits and increasing customs duties.
At current levels, the need to resort to any emergency action is limited.
Finally, from both fundamental and technical perspectives, while some more weakness in Indian rupee is in order, the exact magnitude of weakness is anyone’s guess.
Currencies overshoot at extremes. Another 5 percent depreciation may still qualify as orderly if it is gradual and flow driven. One has to also bear in mind the October US Treasury meeting which would decide on currency manipulating partners.
India already qualified for two of the three criteria in its April 2018 meeting. For the technically and charts oriented analysts, the current levels are in uncharted territories. Still, a weakness towards 74-75 rupee to a dollar cannot be ruled out.
Source: moneycontrol.com