Falling of the Rupee

The performance of the Indian rupee this year has been one of the significant issues regarding the economic situation of the country. The Indian currency has depreciated more than 7% this year and is also termed to be the worst performing Asian currency so far. The rupee slid as much 69.0925 per dollar last week, thereby crossing its all time previous low of 68.8650 from November 2016.

The slump in the currency has its roots in concerns over high crude oil prices. According to Reuters, the crude oil prices have risen by nearly 40% in the past one year, with the US crude oil prices hitting a three and a half year high. Also the unplanned supply distributions from Canada to Libya and Venezuela have contributed to the price rise. A major factor contributing to this high rise in crude oil prices is President Donald Trump’s demand to its allies to stop importing oil from Iran. Due to this, the market witnessed supply concerns that could probably cause a huge drop in crude exports from Iran.

Also, the widening current account deficit has put pressure on the strength of the rupee. The current account deficit increased to 13 billion as compared to last year’s 2.6 billion. Therefore, the imports exceed the exports by a large gap, and as the import payments are made in foreign currency the local currency suffers a huge setback, weakening the domestic currency further. A combination of rising crude oil prices which would stroke inflation and widen the current account gap, and the looming trade war fears that promote outflows from emerging markets is putting massive pressure on the rupee. The currency will continue to be under pressure in the near term as oil prices continue to stay high. The Indian rupee’s downfall is as much reflection of the rupee’s weakness as it shows the strength of the American currency.

As the USA’s debts yields rise higher, the value of the US dollar gets an edge followed by two likely interest hikes next year. As the US interest rates start increasing, all the attention and interest of the foreign institutional investors would shift from the emerging markets such as China, India, South Korea and Philippines to the United States. As a result, not only the Indian currency but all the currencies of the emerging markets have been declining in the recent times. India’s 413 billion dollar foreign exchange reserves act a cushion; however, this has fallen in eight of the nine weeks to June 15. The central bank had to intervene in the currency market to provide support. The reserve bank always intervenes to cut volatility and doesn’t target any levels.

The weakening rupee has effects on many aspects of the economy. A falling rupee increases import costs while increasing export revenue in rupee terms. As India has a deficit, the imports become more expensive. Oil, one of the country’s largest imports, has the potential of increasing the deficit. Normally the foreign capital inflows help in bridging the gap and easing the overall balance of payments, which includes both the capital account and current account balances.

However, given the global risk aversion strategies, these prospects could dim as investors are busy pulling out of relatively riskier emerging market assets. The biggest losers will be importers and oil marketing companies, since they import their main raw material, crude oil. For nationalised oil marketing companies, the under-recoveries (losses from subsidising prices) in diesel, kerosene (through the public distribution system) and domestic liquefied petroleum gas will climb further. With every fall in the rupee, the under-recovery goes up by Rs 9,500 crore per year on these price-controlled products. With pressure to keep rates at higher levels, there may be little relief in interest costs for companies.

According to a Morgan Stanley report, rising interest rates are negatively impacting corporate profits. It is pertinent to note that capital costs-to-sales ratio remains above historical averages. In our view, this is one area of the income statement which could hurt further with slowing growth, and could be a dampener to the earnings, the report said. Companies with foreign currency loans on their books, either as working capital or acquisition-related debt, will also be affected.

The falling rupee also has the potential to fuel inflation throughout the economy at a time when headline inflation is still above 9%. A falling currency, if the trend continues, could compel the Reserve bank of India to keep policy rates high for a longer time. The declining rupee adds to the pressure on corporate markings through higher imported input costs. Higher local prices add to costs. According to a recent Morgan Stanley report, gross margins of companies are at decade lows, mainly driven by higher raw material costs and stiffer competition. Cooling global commodity prices might not afford much relief because the cost of imported raw materials will still be relatively high in rupee terms. The erosion in rupee’s value has adversely hit the bond market too. The ten years benchmark bond yield shot-up to 7.87 per cent from 7.83 per cent on Wednesday. Additionally, for those travelling abroad as tourists or Indians studying abroad, fall in rupee’s value would mean a higher cost of living.

Of course, all these effects kick in only if the rupee continues to fall or stay around these levels for a long period of time. Sharp movements in either direction for a short period of time will not affect the economy dramatically. However, the experts believe that the rupee fall might not stay for long since the decline is primarily attributed to the crude price hike, which might get arrested as the OPEC members on June 22 agreed to raise output from July by about 0.6 to 0.8 million bpd. Besides the current account deficit figure might be alarming if compared with the previous year’s figure, however, it is moderate in relation to the GDP data.

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