Although the rupee has seen a downward graph this year, it hit an all-time low against the US dollar earlier this month. Despite Arun Jaitley’s reassurances claiming that the rupee is doing everything in its capacity to salvage the situation and that there are no domestic reasons attributable to this fall, people cannot help but wonder if our economy is really not at fault. It all seems very foggy at this point so let me break it down for you.
India, Asia’s third largest economy, has been pressured from various fronts both globally and domestically. In the past year, our economy has been seeing various setbacks owing to some important financial decisions like demonetisation, introduction of the Goods and Services tax and of course mounting bad debts in the banking sector. The global factors include Turkey’s economic crisis, the rising crude oil prices and America’s sudden growth amidst other struggling currencies.
According to economists, the rupee has not under-performed so far. Firstly, the depreciation between April and July was an aftermath of the strengthening dollar, the global currency. In a very basic level, if it is expensive to get hold of dollars, there is less money for everything else causing the global monetary policy to be tighter. This means that the prices of other commodities will be higher in non-dollar currencies like ours, causing price rise, inflation and ultimately depreciation of the rupee. In addition to that, emerging markets (EM) like ours that borrow in dollars will now find it more difficult to service their debt, causing the rupee to take a plunge again.
This brings us to the correlation between the dollar and fuel prices. In theory, when the dollar weakens, crude oil prices increase since oil is priced in dollars, although that isn’t always the case. A similar behaviour was noticed in November 2017, as oil prices rose when the dollar steadily weakened confirming a strong dependence. This is the natural hedge that India was benefitting from. However, starting earlier this month, India has been sandwiched between the rising crude oil prices and the strong dollar. This has not proved to be a favourable situation to India’s economy as we’re net importers of oil.
As importers of crude oil, the rise in price can deteriorate growth, spark up inflation and cause twin deficits; Current Account Deficits (CAD) and Fiscal deficits. This causes a ripple effect on consumption and investment behaviour on the economy.The (CAD) is another important factor that could cause further strain on the rupee. CAD is a measure of the country’s trade when goods it imports exceeds the goods it exports. India’s CAD is now 3% of the GDP which amounts to approximately 80 billion, it has risen from 2% in the month of March. The 3.3% fiscal deficit target is also expected to be breached since they have reached 86.5% of the target by July in this quarter, due to crude oil imports which amounts to 40% of the import bill. The falling rupee has made the transaction costlier and is expected to cost 26 billion dollars more than the budgeted $108 billion in this financial year, causing deficit and resulting in a vicious cycle.
From a different perspective, the rupee depreciation is favourable to crude oil exporters in India, causing them to export more and more. This means that that the demand for that commodity will increase in our country while the supply for the same will not be adequate, triggering price rise and affecting local consumers here. Confident exporters are now ceasing to hedge seeing no financial risks while the importers, anticipating more volatility in the value of rupee are hedging more and sending their currency back home due to rising interest rates in the US setting off further weakening of our home currency, widening the CAD.
The speed of the rupee’s decline from 69 to 72 to the dollar in mid-august caused several speculators to worry as the Reserve Bank of India barely intervened. According to some anonymous forex dealer from a state-run bank, the RBI has been selling dollars through both private and public banks to balance the situation. They are determined to not let the rupee fall beyond 72 to a dollar trying to defend its economy. What else can the rupee do to cushion it’s fall other than to just wait?
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