The Indian Rupee Has A Great Fall

The rupee has bitten dust, but there is more pain still to come, Amit Bhanot

Pandemonium reigns in the forex market, as the free fall of the rupee against the dollar has continued unabated for almost three months now. Every new low sent a fresh wave of tremors across the economy, with the latest figure at 61.21 per dollar (as on July 8).

This situation forced the RBI, the SEBI and the Finance Ministry to intervene in bid to curtail the speculation underlying rupee trade. The gravity of the situation can be gauged from the fact that the apex bank and the capital market regulator simultaneously acted against the speculators in their respective capacities by curtailing currency derivatives trade by banks and raising the margins for non-banking trade. Though this brought some respite to the rupee, and it rebounded to a level of 59.72. Of course, this fell below the 60 mark again owing to a sell-off by FIIs, particularly in the debt markets.

Though on paper it seems that the apex bank and the government are acting swiftly to arrest the fall, the global situation is adding to the gravity of the scenario. Experts feel that the high Current Account Deficit (CAD) situation, India’s reliance on fuel imports and the overdependence on (now scarce) foreign inflows to fund CAD will continue to pressurise the rupee, which can touch much lower levels in the coming weeks.

RBI Missing Muscle Power

At present, the biggest concern for a central bank of emerging markets (EMs) is to somehow curb volatility in the respective currencies. But with limited resources they have limited options, as the flight of capital from EMs to US is huge. In fact, FIIs had pumped in USD 4.2 trillion into EMs since the US Federal Reserve started its QE program, and now we are seeing a reversal of this trend. On the other hand, India’s forex reserves stood at USD 255 billion in the week ending June 28, falling by USD 3.16 billion during the week. In this respect, Anil Kumar Bhansali, VP, Mecklai Financial says, “Considering this, the RBI does not have the ammunition to arrest the decline in terms of reserves, but it can always do so by making more of verbal interventions, and cautioning speculators and banks against taking speculative positions in the currency”.

On the other hand, better-than-expected recovery in the US has proved to be a double whammy for countries like India. First, the recovery is causing the differential return from the EMs’ debt markets narrow down in comparison with the US bond yield, resulting in FIIs’ exodus from the debt market – FIIs sold assets worth Rs 39597 crore during June and July 2013.

Secondly, the Fed’s announcement about tapering off QE3 stimulus by the end of this year signaled a significant break. “The era of easy money is over, as EM investments are like luxury investments for FIIs. In a liquidity crunch situation, they are making a decisive exit from markets like India, unlike in the past when they did trading activity”, explains Jagannadham Thunuguntla, Head – Equity, SMC Global. “Considering this, the rupee can touch the level of 65 in the near term”, he adds.[PAGE BREAK]

India In A Vicious Cycle

The rupee’s decline has kick started a vicious cycle for the Indian economy. Indian imports, especially oil, are swelling with each passing day due to the sudden currency depreciation, pushing up the domestic prices and ultimately inflation. “This will put extra burden on already high CAD and announcement of populist schemes in election year like right to food would only add to fiscal deficit woes. This only adds up to problems for rupee”, maintains economic expert Shivkant Vaish.

With the phasing out of QE and the departure of FIIs, the rupee situation would worsen further. “India is dependent on global liquidity for funding its CAD. We received inflows of USD 32 billion last year and another 20 billion this year before the FIIs began to withdraw from the debt segment. We have a trade gap of USD 200 billion, which has to be funded by foreign inflows”, Bhansali points out. “Considering this, we have to bear pain in the short term as FIIs may not really be interested in bringing in funds till they find stability in the value of rupee and also see the economy returning to a growth of over six per cent”, he adds.

Growth will also take a hit in the present situation. Due to rising inflation and declining rupee, the RBI will find it difficult to cut the interest rates, though this would be an imperative to fuel the growth engine. Thus, there is little likelihood of the economy receiving a short-term spurt.

Stacked on top of each other, these factors are building excessive pressure on the rupee. 62 is surely on the cards for the currency, and we can also see it touch the 65 levels in the medium term unless there is some real action from the government on the trade front and from the RBI in terms of controlling value.

Rupee May Tumble Further: CII Survey

As per a recent survey by the CII, the business community and experts feel that the rupee would continue to remain volatile and may weaken further against the dollar during the next quarter if the downside risks accruing from the high CAD and dwindling of FDI flows remain unaddressed. The survey demonstrated a subdued outlook of the rupee, with most respondents expecting it to trade above the 59 mark to a dollar by end September.

Chandrajit Banerjee, Director General, CII holds, “We need to move fast on the next round of reforms. We have to tackle the bottlenecks to make India an attractive business destination for investors to prevent excessive volatility and downward pressure on the rupee”.

A majority of the survey respondents reported that the weak rupee would contribute towards imported inflation in our country and its consequent impact on our WPI. This may discourage the central bank from cutting the policy rates in the next monetary policy review.