Rupee slides to record low against US Dollar!
This headline has been the spotlight for all of us for quite a few days now!
Indeed, the currency’s fall gets more attention than its rise.
What the newspapers don’t say (but which our Hon’ble Finance Minister Smt. Nirmala Sitharaman pointed recently) is that almost all currencies are falling against the dollar, and the rupee has fallen less than most of them – 6 per cent in the first half of 2022.
Compared to that, the Euro has fallen by around 8 per cent, the yen by 18.2 per cent, and the pound by 13.2 per cent. China’s yuan has fallen less (3.6 per cent), but the currencies of Australia, South Korea, and of course Pakistan have fallen more. A more accurate headline should therefore be that the rupee has moved up against almost all currencies. But that news is missing.
I found this piece of news so engaging, so couldn’t help but do an in-depth analysis of this situation. Do read this article to get insights of the same!
Rupee plunges to all time low!
As anyone would probably assume, I too believed that a falling currency has necessarily an adverse effect on our country’s economy, which somehow is correct, but little did I know that it is not necessarily an indicator of a poor economy, at least in the short run.
Almost every country with a successful long-term record of development (Japan and China being among the best examples) has pursued a “weak currency” policy in order to win export markets. They rather devalue currency. The reason is simple: If you are competing primarily on price, a weak currency helps. Over time, as exports gain momentum and the economy achieves external viability, the currency reverses its decline.
Too many people tend to get wrong this long-term cause-and-effect relationship between country and currency. A strengthening economy gets a strengthening currency, helped along by capital flows. It certainly is not the other way round: A weak economy, or one with high inflation, does not become strong if you artificially boost its currency, such a policy would not be sustainable, and would risk capital flowing out. Thus, assuming a strong currency to be the best indicator of economy would repudiate this fact. Further, a country’s currency is affected not only by internal factors, but external factors too play a major role in defining its value.
Talking about India, the framers of our Monetary Policy have rather believed in a stable or a strong Currency Policy.
The Commerce and Industry Minister, Shri Piyush Goyal remarked that even though due to the weakening of rupee, India will gain through exports, it would not be in the nation’s long-term interest. He emphasized that the currency devaluation is actually detrimental to a nation’s interest, growth story and impacts its competitiveness in the long run.
Since, it impacts economy in the longer run, it necessitates me to discuss the reasons behind the slump in Indian Rupees and whether they are a matter of concern.
The value of the Indian rupee to the US Dollar works on a demand and supply basis. If there is a higher demand for the US Dollar, the value of the Indian rupee depreciates and vice-versa. If a country imports more than it exports, then the demand for the dollar will be higher than the supply and the domestic currency like Rupee in India will depreciate against the dollar.
Some of the key reasons are explained briefly:
- Geopolitical risks
Uncertain global conditions have triggered a risk appetite for the weakening of rupee. In fact, rupee has been under significant pressure ever since the disturbance of geopolitical situations owing to Russia’s invasion of Ukraine.
The crisis spiked fears of global inflation, thereby pushing up prices of essential commodities worldwide. Crude oil prices are soaring to record highs in wake of supply restrictions, given that India imports more than 80% of its crude oil and is the third largest importer of oil in world — witnessed a significant rise in its import bill. Since Russia invaded Ukraine in February of this year, the price of crude has consistently remained at or over $100 per barrel. Inflationary pressures in the economy will only increase as a result of high oil costs and a declining rupee.
- Foreign Fund Outflows from Domestic markets
There have been heavy foreign fund outflows from the domestic markets as the foreign institutional investors (FIIs) have sold shares worth $28.4 billion so far this year, surpassing the $11.8 billion
sell-off recorded during the Global Financial Crisis of 2008. In addition, there have been significant outflows of foreign funds from domestic markets.
As money flows out of India, the rupee-dollar exchange rate gets impacted, depreciating the rupee. Such depreciation puts considerable pressure on the already high import prices of crude and raw materials, paving the path for higher imported inflation and production costs besides higher retail inflation.
- Increase in interest rates in US
High interest rates indicate that a country’s currency is more valuable. From a foreign investor’s perspective, saving or investing in that country is more likely to yield better returns. Thus, this would increase the demand for that country’s currency.
In the aftermath of the Covid shock, interest rates in the US moved down to near zero to support the economy. Low interest rates in the US and other advanced economies increased the interest differential and attracted dollar inflows in emerging markets such as India.
In March this year, US Federal Reserve raised the benchmark interest rates by 25 basis points from near zero. Its first-rate hike since 2018. Moreover, in June, the it announced the biggest interest rate rise (75 basis points) in nearly 30 years as it ramps up its fight to rein in soaring consumer prices. (A week before this, India increased the interest rates by 50 basis points).
Speculations are there could be more aggressive rate hikes by the US Fed and that may further dent the Indian currency.
These factors alone do not determine exchange rates and the value of a currency in foreign exchange markets. Other factors such as internal political stability, inflation, the overall balance of trade (the total difference between imports and exports across all its trading partner countries), gross domestic product (GDP) and government debt are equally important.
How is RBI playing its role?
The Reserve Bank’s exchange rate policy focusses on ensuring orderly conditions in the foreign exchange market. When necessary, it intervenes in the market by buying or selling foreign currencies. The market operations are undertaken either directly or through public sector banks.
The central bank is said to have sold dollars at 78.97-78.98 per US dollar and has heavily expanded its foreign exchange reserves to shield the rupee from a runaway depreciation.
There are chances that the central bank may intervene further as the rupee sees a further decline.
What Next?
What to expect out of this situation cannot be predicted with certainty as a lot depends on external factors not in control of an ordinary man.
“We believe depreciation pressure on the rupee will continue to persist in FY23,” QuantEcon Research said in a note, adding that it expects ” the rupee could weaken towards 81 to a dollar before the end of FY23,” Reuters reported.
On a final note, these words by Jamal Meckali, Founder & CEO, Mecklai Financial Services, leading Financial service provider, briefly describe what one must expect on the future state of affairs:
“At the best of times, it is impossible to forecast the market and currencies, but volatility is so high you should not even try. I know it is your job to tell people what is going to happen, but you do not know, and I do not know, and they do not know.”
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