The rupee has fallen about 7% against the dollar this year.
rupee @ 80.
It’s all over the news. Even if you’ve been on a digital detox in the past week, you’ve probably heard of it.
The Indian rupee fell to a new all-time low of 80 against the US dollar this week. The rupee has fallen about 7% against the dollar this year.
This raises questions, concerns and emotions. The emotions are understandable. People are upset. Politicians throw mud at the government.
But the concerns and questions that arise at this time are more important than the reflexive emotions in response to the rupee’s decline.
Let’s understand the concerns first.
The big concern
Well, there is one big concern called “imported inflation.”
India is a net importing country. This means that we import more than we export. According to government data, India’s imports were $610.22 billion and its exports $417.81 billion in FY 2021-22.
Since the US dollar is the world’s reserve currency, it is also the main billing currency in the world for goods and services. If the US dollar strengthens, ie the rupee weakens, import costs rise.
This will also be the case if the input volume remains the same. This means that all imported goods become more expensive. This is called imported inflation.
The costs of India’s major imports – crude oil, natural gas, all kinds of minerals, machinery, electrical equipment, appliances, chemicals – have all risen significantly. This makes inflation in India, which is already high anyway, more difficult to control.
As a country, for example, we cannot simply reduce our consumption of crude oil. So even if the price of crude oil remains constant in the international market, gasoline prices will rise as the rupee falls against the dollar.
Imported inflation is being felt in the Indian economy. It has contributed to homegrown inflation and made life difficult for the common man.
Another concern is external debt.
This is the debt expressed in foreign currency. Thus, principal and interest payments must be made in foreign currency, usually US dollars. If the rupee weakens against the dollar, more rupees are needed to repay the dollar loan.
According to the RBI, India’s external debt stood at $620.7 billion at the end of FY22. It’s a big number, and it’s increased by $42.1 billion in one year. And with the dollar soaring, foreign-indebted companies will find it increasingly difficult to repay.
Now let’s talk about the questions that the decline of the rupee raises. Specifically, we ask, why is the rupee falling and what is being done to stop the decline?
Reasons for the decline
There are a few main reasons for the fall of the rupee. By far the largest is the flow of capital to the US.
The US is usually an exporter of capital. It imports more than it exports. The wealthy citizens invest abroad to increase the return on their portfolios. Immigrants who work in the US send money back to their home countries.
A country that receives a lot of capital from the US through exports, foreign investment (both FII and FDI), remittances, tourism, etc., may have a current account deficit. This means it can import more than it exports. They can do this thanks to the cushion provided by all the money pouring in.
India has benefited immensely from this trend. It has historically managed to keep a current account deficit within a narrow range since 1991. It hasn’t had too much trouble financing it.
A natural consequence of this is, of course, a steadily depreciating currency. This is not a problem in good times when money is pouring in. In fact, even if money flows out, it’s still not a problem as long as the currency is stable and the current account deficit is low.
This was the case with India in FY22. The current account deficit was low at 1.2% of GDP. The rupee was relatively stable. Foreign direct investment poured in. Export growth was strong.
So the market wasn’t overly concerned about FII sales like there was no tomorrow.
The situation is different now.
Commodity prices, including crude oil, rose as the war between Russia and Ukraine began. These goods rose even before the war. The war made imports from India more expensive.
The rupee also began to fall as more money fled to the safety of the US dollars and fears of continued high inflation emerged.
FIIs have raised approximately $14 billion so far this fiscal year. Add to that the fact that the current account deficit is expected to reach 2.9% of GDP this year.
The second reason for the decline in the rupee compounded the problem: US interest rate hikes.
Inflation in the US is at a four-decade high. The CPI is within 10% hitting distance.
The US Federal Reserve has aggressively raised interest rates to curb inflation. All indications point to even more aggressive rate hikes in the near future. This makes the US dollar stronger by increasing demand in two ways.
First, investors get a higher risk-free rate from US Treasuries. This attracts more money to the US.
A second higher interest rate increases the likelihood of a recession. This has been the talk of the town in the financial markets for months.
The likelihood of a recession in the US has increased recently and this has made markets anxious. In a fearful environment, money tends to look for the safest investment. US Treasuries fulfill that role perfectly. This further increases the flow of money to the dollar.
These reasons have caused the US dollar to move higher against most currencies around the world. And the rupee is no exception.
What is being done to stop the decline?
The government and the RBI have been trying to raise the rupee for a while now. They have taken many measures for this.
The RBI has intervened and spent more than $40 billion of India’s foreign exchange reserves in defense of the rupee. It has intervened in the forex market several times to lower volatility in the rupee.
It recently announced a series of measures, including the liquidation of foreign trade in rupees, to help strengthen the currency.
The government has announced measures such as raising excise duties on gold and petroleum products.
However, the markets are unimpressed by these moves, at least in the short term.
Conclusion
The talk on the street now is that the rupee will depreciate to 82 against the US dollar in the near term.
If you are looking for investment ideas, we recommend watching this video – How to Profit from a Rising US Dollar.
Also read our recent articles on how IT stocks profit from a falling rupee and the 5 stocks that can profit from a falling rupee.
Disclaimer: This article is for informational purposes only. It is not a stock recommendation and should not be treated as such.
This article is from Equitymaster.com
(This story was not edited by DailyExpertNews staff and was generated automatically from a syndicated feed.)
