Why is the Indian Rupee falling and how does it impact you?

The rupee finally breached the dreaded psychological barrier of 80 per dollar this week. The rupee has weakened by over 7 percent year to date against the US Dollar and by around 25 percent since December 2014. Added to the record high inflation levels, and increase in GST for daily-use products, the fall of the Indian rupee against the US Dollar is understandably adding to the pessimism for the Indian economy.

As any macroeconomist will endorse, depreciation of the national currency is not the primary indicator of the state of the economy. The issue is much more nuanced with many interdependent factors at work. Let’s look at the issue holistically and understand the rationale for the fall in the rupee, its impact on the economy, and the steps being taken by the authorities to minimize the impact.

Cause

Nirmala Sitharaman, the finance minister has attributed the depreciation of the Indian rupee against the US Dollar to global factors like soaring crude oil prices and the Russia-Ukraine conflict.

However, another significant contributor to the fall of the Indian rupee is the strengthening of the US Dollar. It is not about the fall in the rupee as much as it is about the rise in the US Dollar. The Indian rupee has strengthened against major currencies such as the Euro, British pound, and Japanese yen though it has weakened against the US dollar. The dollar has gained more than 10% this year and is now at a 20-year high. The continued rise in the greenback is primarily driven by inflation levels in the USA which are currently at a 41-year high because of which interest rates are being raised aggressively by the US Fed.  The threat of Russia cutting off gas supplies in winter coupled with the slow intervention by the European Central Bank (ECB) to control inflation are ripe grounds for a recession in the EU. This is causing investors to sell Euros and buy dollars instead, reinforcing its status as safe-haven in times of uncertainty. In addition, the increasing import bill due to rising international commodity prices is boosting the demand for dollars locally. These are only adding to the shortage of the greenback and leading to the appreciation of the dollar

The exodus of foreign portfolio investors (FPI) from Indian markets is only precipitating the crisis. The net outflow by FPIs from equities in the first six months of 2022 has reached a record high of Rs 2.25 lakh crore. In comparison, they withdrew Rs. 52,987 crore in the entire 2008.

Impact

The fall in the rupee value has had a far-reaching impact on many areas of the economy as well as a few benefits.

Higher Fuel Prices

India imports 80% of its oil requirements which is mostly paid in US Dollars. With international crude oil prices at a decade high, India has to pay a higher amount of dollars for its energy imports. The oil prices locally have risen 2 percent due to global factors, but 6 percent due to the depreciation of the rupee. Every Re 1 fall against the US dollar contributes to an increase of 2 paisa/unit in tariffs locally. There is only as much as the government and states can absorb within their already fragile budgets and the exchange rate burden will eventually be passed by the oil refineries and marketing companies onto the consumers. This also has an impact on the current account. India’s current account deficit stood at $13.4 billion or 1.5% of GDP in the quarter ended Mar’22.

Inflationary Pressure

As per RBI’s Monetary Policy Report published in April, if the rupee depreciates by 5 percent from 76 per dollar, retail inflation could edge up by around 20 bps.

Costlier Foreign Education and International Travel

Travelers and students studying abroad will see a spike in their budgets given the higher price they have to pay for purchasing dollars. Students studying abroad and with a limited budget are particularly hard hit as their parents have to remit more rupees for the tuition fees and living expenses.

Not all is gloomy though. The upside of a weakening rupee is that Indian goods and services become that much cheaper for exports. IT companies are the biggest gainers as most of their client billings is in US Dollars. The Americas contribute about 50-60% of their revenue and a 100-bps fall in the rupee against the dollar straightaway translates into a 30-bps operating margin benefit.

Efforts by the RBI and Government

In keeping with its mandate to control inflation and manage currency fluctuation, the Reserve Bank of India (RBI) has announced a slew of measures:

• It raised interest rates in recent months (with more expected in the coming months) to not only curb inflationary pressure but also to increase the attractiveness of holding Indian rupees for residents and non-residents.
• It raised the overseas borrowing limits for companies and liberalized norms for foreign investments in government bonds to boost foreign exchange inflows.
• The RBI also increased the External Commercial Borrowing (ECB) limit under the automatic route from USD 750 million or its equivalent per financial year to USD 1.5 billion, and eased norms for foreign portfolio investments in the debt market.
• It has been intervening in both the spot and forward markets by purchasing dollars to slow the rupee's fall. This has also had an adverse impact on the foreign exchange reserves which are now at a 15-month low, equivalent to just 10 months of import.

The government on its part has introduced a mechanism to settle international trade in rupees which will make the trade with countries facing US sanctions (especially Russia) easier. Russia has become India’s second-largest oil supplier since the start of its war with Ukraine as India aims to capitalize on cheap crude and lower its import bill settled in US Dollars.

With the US dollar set to strengthen even further and the global headwinds not seeming like getting a breather anytime soon, the rupee is only expected to weaken further. How soon and how much will depend on the RBI and the government policies. In the current times, one can only be best advised to hold their investments in dollars.