Global developments such as strengthening of the US dollar (USD), high commodity prices (especially crude oil) and tighter monetary conditions in the US, coupled with domestic factors such as expanding trade/current account deficit, inflationary pressures and likely fiscal slippage, are impacting the rupee, according to India Ratings (Ind-Ra).
The credit rating agency expects the rupee to average 69.79/USD in FY19 (April-September 2018 average: 68.57/USD), a depreciation of 8.3 per cent. This is, however, contingent upon mobilisation of $30 billion from non-resident Indians, similar to 2013.
Although the depreciation in rupee versus dollar so far is at a five-year high, a longer term view, as per the agency, suggests that average depreciation during FY15-FY19 will be only 3 per cent. This is at par with 20 years’ average depreciation (FY99-FY18) in rupee versus the dollar.
Sharper depreciation
Countries with higher fiscal and current account deficit witnessed a sharper depreciation of their currencies. Thus, the currencies of Argentina, Turkey and South Africa, have depreciated more than the rupee in 2018.
“The sharp deterioration in rupee versus dollar over the past few months is a clear reminder of the vulnerability of Indian economy to the global events. This is the fourth instance of a sharp deterioration in rupee versus the dollar in the current decade,” said Ind-Ra.
The first bout of rupee depreciation occurred during August-December 2011, and was triggered by the euro debt crisis. The second occurred during March-June 2012, triggered by the likelihood of Greece’s exit from the eurozone/global credit freeze, and some adverse announcements made in the Union Budget of FY13, such as the general anti-avoidance rule and its implementation from retrospective effect.
The third occurred during May-August 2013, and was triggered by the increased likelihood of US Federal’s tapering off quantitative easing programme.
“In all these instances, however, the fundamental reason for rupee depreciation was a sudden pressure on current account deficit, coupled with capital flight from the country,” said Ind-Ra.
Referring to the sudden spurt in crude oil prices and a reversal in capital flows, the agency elaborated that while crude oil prices rose in response to the sanctions imposed by the US on Iran, capital flows changed from an inflow to outflow due to an upturn in the interest rates in the US.
“Since more than 80 per cent of the country’s demand is met by imported crude oil, it immediately widened the trade account. While India’s dollar requirement to fund merchandise imports went up, there was no commensurate earning from merchandise exports putting rupee under pressure,” the agency said.
In the case of India, the first line of defence for rupee comes from invisibles (remittances plus software earnings), which are invariably in surplus, and along with the trade account, constitutes current account.
However, invisibles could not grow at the same pace as our merchandise import grew due to higher crude oil prices post April 2018. This widened the current account, bringing the rupee under pressure.