The slide of Indian rupee

The Indian rupee breached the 78 mark against the US dollar for the first time in the currency’s history and touched a lifetime low of 78.28 before closing at 78.13 on Monday. The Indian currency has been performing poorly this year and since January it has fallen 5% vis-à-vis the US greenback.The primary reasons are the strong dollar, surging oil prices, and dollar outflows from Indian capital and bond markets.

However, the rupee is not the sole loser, many Asian and emerging market currencies too are undergoing a similar erosion of value. The US dollar index has, of late, been rising and outperforming the other currencies in the index - namely the Euro, Swiss Franc, Japanese Yen, Canadian Dollar, British Pound and Swedish Krona. Russia’s war in Ukraine, China’s lockdowns, the economic slowdown in Europe and Japan, and US Federal Rate increases have strengthened the US dollar.

The investors see the US as a safe haven in comparison with more volatile markets in Asia and Europe. As India depends on imported crude oil to cater to 85% of its fuel needs, the surging global crude oil prices and a weakened rupee make imports costlier. This impacts Indian industries’ profitability due to increased production costs, which leads to an increase in prices of goods and services, and fuels inflation. India’s retail inflation has continued to remain higher than the tolerance threshold of 6% since January. In May it was 7.04%.

The Reserve Bank of India has already raised key interest rates by 90 basis points since April to rein in inflation. A weak rupee may help exporters, but if they have to rely on imported components and raw materials then this advantage gets negated. Foreign investors’ withdrawal from Indian equity and bond markets continues unabated. In 2022, they have so far pulled out nearly Rs 1.81 lakh crore from stock markets and have remained net sellers in most trading sessions.

The recent increase in policy rates by the US Federal Reserve to fight inflation has also enthused investors. The US central bank had raihad raised its policy rates by 25 basis points in March after a gap of three years, followed by another hike of 50 basis points in May. This improves the return on dollar assets compared with those in India and other emerging markets. With the US inflation rates touching a 40- year high recently, market analysts expect more rate hikes in the coming months.

For the Reserve Bank of India, the challenge will be to curb excess volatility and sharp depreciation of the rupee through timely market interventions, and keep the current account deficit (CAD), or the difference between the value of the country’s imports and exports, at comfortable levels. A falling rupee will lead to an increase in CAD and this will increase India’s dependence on foreign funds.