Rupee Depreciation Amid Global Factors

There are a few macroeconomic numbers that have been tracked closely for the most part of this year. Inflation, interest rates, the US dollar exchange rate and foreign exchange reserves. However, none of these numbers have really been to the comfort of the Reserve Bank of India (RBI).  There are various factors at play influencing these indicators, but one thing they all point to is the economic hardship not just in India, but across the globe. These numbers have not been good for any major economy across the globe, in most cases they have been even worse than those of India, including the projected GDP growing very marginally, barely escaping recession. India however, is expected to post a decent GDP growth, much higher than any major economy.

The Indian rupee has experienced its worst slump in years since the start of 2022. As of late September, it crossed the psychological mark of 80 and moved to 83 by mid-October. Its counterparts like the Euro, the British Pound and the Japanese Yen, which have always been strong, have not been spared either and got hammered even badly. The weakness of other currencies has been a bit of comfort as the problem is not localised and is widespread, which offers hope that once the dollar weakens, we can expect the rupee to gain in strength. The dollar index, which measures the strength of the USD relative to a basket of six currencies is around 112-113, its highest levels not seen in two decades. The depreciation this time has been on the back of global concerns rather than domestic issues. However sharp depreciations have occurred in the recent past as well for the rupee, for example, it depreciated 13.8 per cent in one month in August 2013, due to large capital outflows.

The dollar strength could not have come at a worse time for India with high oil prices, supply chain disruptions, increasing food prices and geopolitical uncertainties. The finance minister has cited factors such as the Ukraine conflict and higher crude prices for the depreciation, other reasons have also been prevalent like the exit of foreign portfolio investors and money pulling out of Indian markets, unwinding of carry trades due to reduced interest rate spreads and the hawkish stance of the US Federal Reserve in hiking interest rates. Unfortunately, the RBI has been caught helpless on the outflows of portfolio investment and also had to step in to defend the rupee to cushion it from the excessive volatility.

India’s export performance also is not improving despite a weaker rupee due to inflationary conditions across the globe, which is denting their purchasing power. The higher cost of imports and stagnant exports have increased the trade deficit. In the first five months of the current fiscal year, the trade deficit increased to $124.5 billion from $54 billion in the corresponding period last year. Despite the confidence of the RBI in its ability to contain the Current Account Deficit (CAD) at three per cent of the GDP for FY 2023, this target appears ambitious.

The RBI has been intervening to control the volatility of the rupee, selling dollars to support the currency. The forex reserves have dropped by about $110 billion over the past year due to various reasons, including defending the rupee. While foreign exchange reserves among all emerging markets have been depleted, the magnitude has been higher for India, compared to other nations like China, Indonesia, Malaysia and Brazil.

In uncertain times, global investors shift investments to less risky currency assets, the US dollar has always been seen as a safe haven asset, though this faith is questionable on multiple grounds. Foreign Portfolio Investors (FPIs) have also been heavy net sellers for the most part of the last 12 months, barring August 2022. Net outflows of $29 billion have been recorded in this period, as part of money flowing out of emerging markets in the light of global uncertainties. This is a complete reversal of the trend considering three straight years of positive inflows prior to 2022.

Another drawback for the rupee stems from the external debt repayment falling due. As per RBI data, at the end of June 2022, approximately $280 billion of external debt is due for repayment in the next 12 months, which constitutes a significant portion of the forex reserves, though much of this debt is corporate debt and may be rolled over without much impact. Further, the remittances from abroad which have been a key contributor to balance of payments, may also slow down due to multiple reasons like inflation in the respective countries eating into savings, wait and watch approach by people remitting, for getting a better rate due to constant depreciation of the rupee. 

The RBI on its part has been working to shore up the foreign exchange reserves through different means like the rupee trade settlement on international transactions, access to foreign investors to a larger portion of government debt, giving more leeway to banks to raise money from non-residents in the form of deposits. However, given the global economic scenario, the impact of these measures is not yet significant. The interest rate spread between the US and India has been narrowing due to the US Fed’s hawkish stand and the conservative approach on interest rates by the RBI, such a situation will not augur well for non-resident deposits. 

The rupee trade mechanism has evoked interest in countries like Russia, where our imports are increasing. This may help to conserve foreign exchange in the future, particularly helping oil imports. Russia is arguably the second or third largest supplier of crude oil to India for the most part of this year, and it may continue further due to the retreating demand from the West. Talks are also on, with countries like the UAE and Saudi Arabia for a non-dollar trade settlement.

However, the picture is not completely gloomy. Some good news may be expected in the next few quarters, with the inflation peaking and the interest rate hikes slowing down. The possibility of a recession in the US and Europe is also putting pressure on crude oil and despite OPEC’s significant output cut in September, the rally in oil prices has only been short-lived. The foreign exchange reserves are still at a comfortable level to support at least nine months of imports. The government’s focus on export promotion through Production Linked Incentives (PLI) appears to be showing initial success. As inflation abates, a weaker rupee may definitely help gain export competitiveness.

As per data published by the RBI, based on the indicator, the Real Effective Exchange Rate (REER), the rupee was still overvalued by around 3.5 per cent as of July 2022, when the USD was around 79. With the current round of depreciation and USD being at 83, it should be reasonably safe to presume that the rupee is rightly valued and may not have much downside risk from here unless we see fresh news on the international front adding to the uncertainty and changing the position again.

The Indian stock markets have been holding better than the developed markets which have seen a significant drop from 20 per cent to 40 per cent and are in the bear market territory. India is the fastest-growing major economy in the world currently, and sooner or later we will definitely see both portfolio investments and also Foreign Direct Investment (FDI) coming back in search of growth, which is not available elsewhere.

The RBI may also want to look at floating sovereign bonds like Resurgent India Bonds issued in 1998 or the India Millennium Deposits of 2000 which have contributed well to increasing the foreign exchange reserve position in the past. Such inflows will help ease the pressure on the rupee due to foreign exchange coming in. Further, the RBI also has a USD swap agreement with the Bank of Japan for $75 billion, in extreme cases, this facility can be drawn. Japan has the second-highest foreign exchange reserves in the world (next only to China). A swap agreement with the US Fed may also be explored temporarily again, if possible. Though most swap facilities are never used, they lend confidence to the currency markets. The times are not normal, even the Swiss central bank (SNB) has started drawing on its Fed swap line this year, for reasons unknown.

(The author is a Hyderabad-based Chartered Accountant)