Why Is Rupee Falling against Dollar and What Is The Way Ahead? Where will the Rupee end up? Rupee likely to hit 81 against dollar by FY23-end.
The rupee ended at around 79.30 per US dollar on Wednesday,6th July 2022 not very far from its all-time weak close in the previous session at 79.37.
The Indian currency has been on the decline since early this year, particularly because of supply chains being hit by the Russia-Ukraine war, global economic challenges exacerbated by the Covid pandemic, inflation, high crude oil prices, etc
Widespread pain
The rupee has been witnessing the downward trend for the past few months and has touched its all-time lows multiple times. It hit its record low of 79.38 to a dollar on Tuesday, 5th July 2022. The local currency had stood at 73.77 to a dollar on January 12, 2022, and since then it has fallen by a significant more than Rs 5 and touched 79.16 on Tuesday. Foreign portfolio investors (FPIs) have also pulled out around Rs 2.2 lakh crore from domestic equities in the first six months of 2022, the highest-ever net withdrawal by them.
Speaking of Indian markets, on June 13, the Indian rupee fell below 78.29 to a dollar, a fresh all-time low. The breach of the INR 78 level for the first time indicates possibility of more pain.
The rupee has been steadily falling and there are no signs of it picking up significantly in the near future. The Indian currency ended at around 79.30 per US dollar on Wednesday,6th July,2022 not very far from its all-time weak close in the previous session at 79.37.
Why is the rupee falling?
The value of the Indian rupee compared to the US dollar works on a demand-and-supply basis. When there is a higher demand for the dollar, the value of the rupee decreases and vice-versa.
The Indian currency has been on the decline since early this year, particularly because of supply chains being hit by the Russia-Ukraine war, global economic challenges making it more worse by the Covid pandemic, inflation, high crude oil prices, etc.
If a country, like India, imports more than it export, the demand for the dollar will be higher than the supply and the domestic currency will depreciate against the dollar.
The rupee’s fall these days, experts say, is primarily because of high crude oil prices, a strong dollar overseas, and foreign capital outflows.
There have been heavy foreign fund outflows from the domestic markets as the foreign institutional investors (FIIs) have sold shares worth over $30 billion this year. This goes way past the $11.8-billion sell-off witnessed at the time of the 2008 global financial crisis.
In the backdrop of rising interest rates and unwinding of liquidity, the US dollar index, or the DXY, has been rising relentlessly
since May last year. From a low of 89.5 on May 25, 2021, to 105.65 on June 14, 2022, the index has scaled the levels not seen since July 2002. This has led to emerging-market currencies cracking against the US dollar.
The DXY measures the value of the US dollar against six foreign currencies – the euro, Swiss franc, British pound, Canadian dollar, Japanese yen and Swedish krona – with the euro having the highest weight of 57.6% in the index. Any strength in the euro, as expected post the ECB rate hikes, would soften the rise of DXY or could lead to some correction.
“When the Federal Reserve tightens, it will make the dollar stronger. But when the ECB does something to make the euro stronger, that makes the dollar slightly weaker. So, it will be a kind of a balancing act, an equilibrium, which has to be found based on what the market feels… We all know that the Fed will take it up to 2%-2.5%, and I think this entire year is going to be the year of the dollar,” says Madan Sabnavis, chief economist, Bank of Baroda. "The underlying weak fundamentals of the EM economies on account of higher oil prices, high CAD, elevated general government debt-to-GDP ratio and limited fiscal space to support growth is likely to limit the possibility of much capital pull into the region."
— Indranil Pan, chief economist, Yes Bank
Just last week, the US Fed announced an increase of 75 basis points in interest rates, the biggest rate hike in 28 years. ECB plans to raise rates from July onwards and could announce a possible withdrawal of liquidity built up over the years.
Such depreciation puts significant pressure on the already high import prices of crude and raw materials. This in turn leads to higher imported inflation and production costs aside from higher retail inflation.
As money flows out of India, the rupee-dollar exchange rate gets affected, leading to a devaluation of the rupee.
The US Federal Reserve recently raised the interest rates, and the return on dollar assets grew compared with those of emerging markets such as India. There are also reports of possibly more aggressive rate hikes by the US Fed and this will hurt the rupee further.
So, in summary, the backdrop of heated inflation, Covid crisis, monetary tightening by key central banks, and supply chain disruptions sparked by the Russia-Ukraine war have slowed down global economic activity, leading to the rupee’s massive drop against the dollar.
What then are the solutions to arrest this worrying slide of the rupee?
The government took some steps last week, announcing a hike in the customs duty on gold and a rise in taxes on the export of petrol, diesel as well as ATF, which is expected to control foreign trade in order to curb the depreciation of the rupee. The import tax on gold was also hiked from 7.5 per cent to 12.5 per cent.
The Reserve Bank of India is taking steps to support the currency with dollar sales in the spot, forwards, and other derivatives markets. It is also likely to raise policy rates further as part of a process that is expected to draw foreign investors towards debt assets.
Rupee hit its all-time low of 79.38 to a dollar on Tuesday; FPIs have pulled out Rs 2.2 lakh crore from domestic equities in the first six months of 2022
In order to bolster the rupee and attract foreign investments into the country, the Reserve Bank of India (RBI) on Wednesday 6th July 2022 announced a slew of measures. These include relaxations on cash reserve ratio (CRR) and statutory liquidity ratio (SLR) on incremental FCNR(B) and NRE term deposits, easing rules for FPIs, and raising limits on external borrowings, among others.
The Reserve Bank has been closely and continuously monitoring the liquidity conditions in the forex market and has stepped in as needed in all its segments to alleviate dollar tightness with the objective of ensuring orderly market functioning," the central bank said on Wednesday.
To further diversify and expand the sources of forex funding for mitigating volatility and dampening global spillovers, the RBI has decided to undertake few measures. These are:
Exemption from CRR, SLR on Incremental FCNR(B) and NRE Term Deposits
The RBI has decided that with effect from the reporting fortnight beginning July 30, incremental FCNR(B) and NRE deposits with a reference base date of July 1, 2022, will be exempt from the maintenance of CRR and SLR. This relaxation will be available for deposits mobilised up to November 4, 2022. Transfers from Non-Resident (Ordinary) (NRO) accounts to NRE accounts shall not qualify for the relaxation.
Currently, banks are required to include all Foreign Currency Non-Resident (Bank) [FCNR(B)] and Non-Resident (External) Rupee (NRE) deposit liabilities for computation of Net Demand and Time Liabilities (NDTL) for maintenance of CRR and SLR.
Interest Rates on FCNR(B) and NRE Deposits
The RBI has now temporarily permitted banks to raise fresh FCNR(B) and NRE deposits without reference to the extant regulations on interest rates, with effect from July 7, 2022. This relaxation will be available for the period up to October 31, 2022.
“At present, interest rates on Foreign Currency Non-Resident Bank [FCNR(B)] deposits are subject to ceilings of Overnight Alternative Reference Rate (ARR) for the respective currency/swap plus 250 basis points for deposits of 1 year to less than 3 years maturity and overnight ARR plus 350 basis points for deposits of 3 years and above and up to 5 years maturity. In case of NRE deposits, as per extant instructions, interest rates shall not be higher than those offered by the banks on comparable domestic rupee term deposits," the RBI said.
Easing Rules on FPI Investment in Debt
Relaxing the existing norms on FPI investment in debt, the RBI said all new issuances of government securities of 7-year and 14-year maturity would be made eligible for the fully accessible route (FAR). Unlike other securities, FPI investment in bonds that are designated under the FAR does not have any limits.
RBI also relaxed norms on residual maturity for FPI investments in government and corporate debt. Investments by FPIs in such bonds made till October 31, 2022, are exempt from a short-term limit, according to which not more than 30 per cent of investments can have a residual maturity of less than one year. The central bank also provided a window till October 31 for FPIs to buy money market instruments such as commercial papers with an original maturity of up to one year.
Foreign Currency Lending by Authorised Dealer Category I (AD Cat-I) Banks
Currently, AD Cat-I banks can undertake overseas foreign currency borrowing (OFCB) up to a limit of 100 per cent of their unimpaired Tier 1 capital or $10 million, whichever is higher. The funds so borrowed cannot be used for lending in foreign currency except for the purpose of export finance.
The RBI has now decided that AD Cat-I banks can utilise OFCBs for lending in foreign currency to entities for a wider set of end-use purposes, subject to the negative list set out for external commercial borrowings (ECBs). “The measure is expected to facilitate foreign currency borrowing by a larger set of borrowers who may find it difficult to directly access overseas markets. This dispensation for raising such borrowings is available till October 31, 2022," RBI said.
Raising Limit on External Commercial Borrowings
Under the automatic ECB route, eligible borrowers are allowed to raise funds through their AD banks, without approaching the RBI, as long as the borrowing is in conformity with the prudential parameters of the ECB framework such as all-in cost ceiling, minimum maturity requirements and the overall dynamic ceiling.
“It has now been decided to increase the limit under the automatic route from US$ 750 million or its equivalent per financial year to US$ 1.5 billion. The all-in cost ceiling under the ECB framework is also being raised by 100 basis points, subject to the borrower being of investment-grade rating," the RBI said.
“The global outlook is clouded by recession risks. Consequently, high risk aversion has gripped financial markets, producing surges of volatility, sell-offs of risk assets and large spillovers, including flights to safety and safe haven demand for the US dollar. As a result, emerging market economies (EMEs) are facing retrenchment of portfolio flows and persistent downward pressures on their currencies," the RBI said.
Jyoti Prakash Gadia, managing director of Resurgent India, said, “The RBI has come with the liberalization of forex flows. It’s a two-pronged strategy whereby the central bank has attempted to cause impediments to the flight of FPI on one hand and bring in more dollars with attractive interest rates on the other. Apparently, the RBI is trying to cover any possible shortfall in meeting forex commitments in a short term."
Gadia added that a short-term policy measure for improving forex liquidity may not be adequate to attract funds, particularly on the ECB front. Hence, a broader perspective could have been better even for such a short-term arrangement.
Will that be enough?
“Assuming that the new global energy order implies extended oil market pains, India will have to respond even more strongly in the interim, with enhanced exports and reduced imports. Otherwise, the repeat of RBI currency buffers falling to 15% of GDP (a recipe for external instability, as seen during the 2013 ‘taper tantrum’) cannot be ruled out in coming years. Thus, allowing INR to gently weaken over time is the right strategy, giving CAD space to improve. Thus, we believe the RBI may eventually let the exchange rate adjust to new realities, albeit orderly, letting it act as a natural macro stabiliser to policy reaction functions,” says a research note by Emkay Global Financial Services.
So while there may not be an easy way out, experts agree that India must move strategically towards controlling imports and increasing exports.
The government may also promote the use of indigenous goods more aggressively in the future to cut down on imports and bolster the rupee.
A greater push for e-vehicles is also possible to reduce the dependence on crude oil imports.
EMs will remain under pressure till inflation in advanced economies peaks along with the interest-rate cycle. While many smaller economies such as Sri Lanka, Pakistan and some African nations may buckle under rising rates that threaten servicing external debt, the impact on India appears to be manageable.
This is not to say that India will remain unscathed. Tightening financial conditions have already led to a record capital flight.
But more than USD600 billion of foreign-exchange reserves, rising tax collections, relatively better growth compared with other markets and retail flows into equities will provide a cushion.
As foreign investors completely dump Russia, tempering their enthusiasm on China; India could in fact be a key beneficiary when the tide turns.
Rupee likely to hit 81 against dollar by FY23-end - why?
As per the latest data, the country's trade deficit touched a fresh record of $25.63 billion in June 2022 widening from $24.3 billion in May 2022. From April to June 2022, the trade deficit stands at $70.25 billion.
The widening of trade deficit to fresh record highs has made a case for further depreciation of the Indian rupee against the dollar. The local currency is seen to reach up to 81 by March 2023 end. On Thursday, the rupee hit a record low of 79.33 against the greenback due to a strong dollar and stubborn foreign funds outflow.
In June 2022, India's merchandise exports stood at 37.94 billion - taking the total to $116.77 billion in Q1FY23. Meanwhile, the country's imports climbed to $63.58 billion in the month under review and cumulatively stood at $187.02 billion in Q1 of the current fiscal.
NSDL data showed that FPIs continued to remove their money from the Indian market even in July. So far this month, FPIs' overall outflow stood at ₹7,323 crore from the market (including equity, debt, debt-VRR, and hybrid market). Overall, in the current year, the outflow is around ₹2,34,613 crore.
According to Yes Bank's report, the widening of the trade gap to fresh record highs only increases the concern around the strength of India’s external account to withstand such increases. In Q1 FY23, the trade deficit sums to $70 billion, recording an average monthly trade deficit of $23.3 billion. This undoubtedly is the highest in the series so far. A correction below this level is possible on two accounts - if exports pick up or imports reduce substantially.
"With high-frequency global data on production, sales, GDP, sentiment, and consumer confidence indicators already indicating start of global slowdown, it is unlikely that the exports will register stellar growth to offset the downtrend seen in Q1 FY23. On the other hand, India’s oil imports remain relatively inelastic. As such, amid higher oil prices, oil import bill is likely to remain elevated," the report said further.
Also, the analysts in the report pointed out that the ongoing energy crisis in India does not improve the situation any further. Coal imports are recording fresh series high with each successive print since March 2022. This trend is likely to continue further despite increases in India’s coal production over the last 3-months.
"The start of monsoon season is likely to impact domestic production going forward hence further increase in coal imports is plausible. The government intervention through increase in customs duty on gold by a net 4.24% to 15% could reduce gold imports even as the impact is likely to be marginal, given that gold prices are currently on a downward bias," the analysts note said.
Yes Bank's analysts in their note stated that they consider 3-scenarios for India’s current account balance with average oil prices at $100 per barrel, $110 per barrel, and $120 per barrel in FY23. The note added, "Despite some buffer being expected on the invisible inflows, FY23 CAD is likely to be higher at $93-111 bn in FY23 ($47 bn in FY22). As a % of GDP, CAD is likely at 2.6-3.2% in FY23. As such, weakening external balances, increase in FII outflows, decline in import cover, tightening by AEs, is expected to build downward pressure on USDINR."
Hence, the report said, "we see depreciation bias in USDINR continuing," adding "Our fair price model indicates for an 81.00 level by March 2023."
Here is the interesting read about rupee by Shri MRIGANK DHANIWALA who is Associate Editor - Economy at Moneycontrol --
The good, the bad and the ugly: Where will the rupee end up?
Three scenarios on where the rupee, battered by a global risk-off, but better prepared than in 2013, could go from here
MRIGANK DHANIWALA JULY 06, 2022 / 02:27 PM IST
The Indian rupee has plummeted to fresh all-time lows over the last several days as emerging market assets are battered by a global risk-off, which has triggered a flight to safe-haven assets. Meanwhile, foreign money continues to leave Indian assets even as the trade deficit worsens.
Yet, the rupee has performed better, compared with several of its Asian peers and the Reserve Bank of India (RBI) is committed and well prepared to contain the volatility in the exchange rate.
India is also no longer a part of the so-called ‘fragile five’ economies that had seen hefty capital outflows and currency meltdowns in 2013.
Going ahead, the key variables that would decide the trajectory of the rupee’s exchange rate are the Russia-Ukraine war, crude oil and commodity prices, the depth of the European slowdown and US recession, and how central banks react.o what are the likely paths for the currency from here?
The good
This is a less likely scenario and one that most forex analysts expect won’t play out anytime soon.
But if it does, the most the rupee could appreciate to is the level of 76.00 to 76.50 to the dollar, analysts said.
For this to happen, crude oil prices will need to continue to cool down and stay below the recent peaks, the US recession would need to be shallow and short, and the Russia-Ukraine war must not escalate further, thus preventing a further spike in food and commodity prices. That may be wishing for a lot.
Still, if these conditions were to unfold, the RBI would not allow the rupee to appreciate much against the greenback.
“The modus operandi of the RBI is pretty clear,” Anindya Banerjee, vice-president, currency and interest rate derivatives at Kotak Securities, said. “When it is a weak dollar, the rupee will appreciate much less than other currencies.”
As soon as the rupee gets to a level of 77.50 or 78.00 to the dollar, the central bank will start buying dollars, said Abhishek Goenka, CEO and Founder at IFA Global.
The bad
This is the base case, with the rupee likely to depreciate gradually, going forward, guided by the RBI’s gentle hand. Policymakers prefer such an approach as it will correct the rupee’s overvaluation and ensure that Indian exporters and importers are protected.
The rupee-dollar pair has been one of the least volatile dollar pairs in the recent past, a testimony to the central bank’s deft management of the foreign exchange market.
“The trajectory of the rupee right now is definitely weak,” said IFA Global’s Goenka. “I am not very bearish on the rupee. I do expect that possibly we could see 80-plus but that is not something that cannot be controlled.”
The central bank is expected to support the currency with not only dollar sales in the spot, forwards and other derivatives markets but also by hiking policy rates further, which will make debt assets more attractive for foreign investors.
Note that, currently, the rupee is overvalued by around 4-5 percent on a real effective exchange rate basis.
The ugly
The following are the possible scenarios which could play out following a sharp depreciation in emerging market currencies amid huge outflows, if the US recession turns out to be much worse than expected.
The rupee could hit 83.00-83.50 to the dollar although weak risk sentiment could push the currency further lower.
To be sure, the RBI, which has been walking the talk with its hefty dollar sales, will curb the fall in the rupee, if the worst is to happen.
The central bank is estimated to have sold $30 billion-$40 billion in the spot and forwards markets over the past six weeks. Even if foreign outflows were to accelerate, the RBI is capable of offsetting those as it seeks to maintain the rupee’s performance among the EM pack.
“RBI has ample reserves, so even if they intervene another $50 billion - $60 billion, they can comfortably absorb it,” Kotak Securities’ Banerjee said. “They have enough. For the Indian rupee to become an outlier, I think it looks unlikely.”
Finally, the bottom-line across the three scenarios is that the market and the central bank are in sync and there is no panic like we saw during the taper tantrum in 2013.
Source: Money Control, Live Mint, News18.com, Economic times, rbi.org.in (Liberalisation of Forex Flows (Revised)); India’s External Debt as at the end of March 2022