Due to a perfect storm of global headwinds, the Indian rupee has been subject to significant selling pressure and analysts predict that this pressure will continue in the months to come.
The Indian rupee has recently plumbed record lows and at least twice exceeded the 80 rupees to one dollar mark in July. Only until the Reserve Bank of India (RBI) intervened to stop the decline did the rupee begin to recover.
Since then, the currency has made some progress; on Thursday, it was trading at about 79.06 to the dollar.
Policymakers acted quickly in reaction to the recent significant drops to allay worries about a rupee sell-off that could push prices much down.
In a written statement to parliament at the end of July, Finance Minister Nirmala Sitharaman explained the devaluation of the rupee as being caused by outside factors.
The ongoing conflict between Russia and Ukraine, rising crude oil prices, and tightening global financial conditions are just a few of the international variables that are contributing to the Indian rupee’s decline against the dollar, according to her.
Analysts concurred that the euro is experiencing worldwide pressure from a number of angles.
Energy prices are on the rise
Due to India’s susceptibility to high energy prices, the rupee has lost more than 5% of its value against the dollar so far this year.
India, the third-largest oil importer in the world, is particularly affected by the rising energy prices because it normally pays for its oil in dollars. The cost of buying oil increases as the rupee declines.
Nomura analysts estimate that India’s import cost rises by $2.1 billion for every $1 increase in the price of oil.
Since March, when Russia’s invasion of Ukraine started, there has been a “substantial spike” in Russian oil shipments to India, and New Delhi appears poised to continue purchasing cheap oil from Moscow, according to industry observers.
According to early statistics from June and financial advice firm Again Capital, India’s supply of Russian crude increased to roughly 1 million barrels per day from 800,000 barrels per day in May.
“Usually, weaker currency acts as a pressure valve to restore external stability by making exports more competitive and reducing demand for imports by making them more expensive,” remarked Adarsh Sinha, co-head of Bank of America Securities’ Asia-Pacific Foreign exchange and rates strategy.
“Oil imports from Russia, if settled in rupee, would reduce dollar demand from oil importers. These rupees could be used to settle payment for Indian exports, and/ or invested into India – both could be beneficial,” he told.
A system for international trade settlements in Indian rupees was established by the central bank of India in July. According to commentators, the step will contribute in the long-term objective of internationalising the Indian currency by allowing traders to bill, pay, and settle imports and exports in Indian rupee.
“This move is constructive for the rupee in the medium-term as higher INR [Indian rupees] demand for settlements implies lower demand for forex for current account transactions,” according to a recent letter from DBS bank senior vice president and economist Radhika Rao.
This will make things easier to “trade with neighboring countries, with trading partners who are unable to access dollar funds and/are temporarily outside the international trading mechanism and those looking to broaden their pool of trade settlement currencies,” she wrote.
Remittances continue to grow
While a depreciating rupee makes it more difficult for India to acquire goods from other nations, it can also increase remittances to the nation from overseas.
According to World Bank data, remittances to India increased by 8% to $89.4 billion in 2021 as a result of the US economy’s recovery, which accounts for a fifth of the nation’s remittances.
“Remittances could be determined by many factors but [a] weaker rupee helps increase domestic value of those remittances which would help offset inflationary pressures for the recipients,” Sinha from BofA Securities stated.
Additionally, Goldman Sachs stated in a recent report that remittances to India “should remain resilient on the back of stable economic growth in the Middle East, benefiting from higher oil prices.”
Problems with deficits
Analysts cautioned that despite this, India’s expanding current account deficit is projected to continue to weigh on the rupee. This is made worse by continuous sizable capital outflows.
“India’s external balances are deteriorating, driven by a terms-of-trade shock from elevated commodity prices, which is resulting in wider current account deficits,” remarked Goldman Sachs economist for India Santanu Sengupta.
When a country’s imports are more than its exports, a current account deficit results.
In a market scenario where emerging market portfolio inflows are not encouraged, “we estimate a large balance of payments deficit. This has meant continued FX reserves drawdown across spot and forward books held by the RBI,” he added.
Indian stocks have already seen $28.9 billion in net foreign withdrawals year to year in July, ranking second among Asian economies other than Japan, according to a recent note from Nomura.
However, India’s substantial external reserves “have provided confidence in RBI’s ability to prevent tail risk scenarios from spilling over to domestic interest rates and impacting growth further when it is already going through a rough patch due to higher commodity prices and supply disruptions, along with tighter monetary policy,” said Sinha.
“Our projection of balance of payment deficit indicates a shortfall of USD 30-50bn this year. RBI has adequate reserves to sustain intervention for at least another year,” he added.
The central bank has unveiled a host of initiatives targeted at promoting capital inflows in an effort to safeguard the rupee. Among the proposals are loosened rules on foreign deposits, loosened standards for foreign investment flows into the debt market, and loosened rules for external commercial borrowing.
The ‘taper tantrum’
Despite the rupee’s current underperformance, economists claimed that compared to the “taper tantrum” in 2013, the rupee’s decline is still more restrained this time around. They cited stronger fundamentals for their claim.
The Federal Reserve’s decision to reduce its exceptional monetary stimulus at the time resulted in a sell-off of bonds, which increased Treasury yields and strengthened the U.S. dollar. As a result, money began to leave emerging markets.
“Much of [the Indian rupee’s] depreciation pressure stems from sharp gains in the US dollar as the latter benefits from wide rate and policy differentials,” said DBS’s Rao in a recent note.
Compared to the taper tantrum, there is less pressure to support the rupee’s fall, she continued. The government has choices, such as postponing procurement of large defence equipment that would help to lower the demand for dollars, she said, if circumstances do worsen.
The external balances of India, which are frequently identified as a source of weakness, have some built-in protection against risks of additional currency devaluation, according to analysts.
“Until now, even in the face of deteriorating external balances, the stock of FX reserves were limiting India’s external sector vulnerability, and have allowed for a slow depreciation of the INR (vs. the USD),” said Sengupta.
“Going forward, as FX reserves get depleted, and real rate differentials shrink, India’s external vulnerability risks will increase — though they will likely compare better than the ‘taper tantrum.’”
Will the rupee drop to Rs.82 for a dollar?
The rupee will face additional downside risks in the upcoming months as global conditions continue to be in flux, economists predicted.
“With global capital flows drying up in a Fed tightening cycle, US recession risks coming to the fore, and India’s external balances becoming challenging, we are likely to see continued weakness in the INR going forward,” said Sengupta.
The bank predicts that during the following three to six months, the Indian rupee might trade at a rate of 80 to 81, “with risks tilted towards even further weakness in the event of more acute dollar strength,” he added.
Some analysts even predict that the rupee will test brand-new lows soon.
The head of global FX strategy at Nomura, Craig Chan, stated that he does not think the level “80 is sacrosanct.”
“We do not believe there is any particular market positioning factor that should lead to an accelerated move higher in USD/INR if 80 breaks – unlike in 2013,” he continued, mentioning the “taper tantrum” phase. “Our last call was INR [rupee] risks breaking the 80 to dollar level and overshoots to 82 by the end of August.”
A further prediction made by Sinha of BofA Securities is that the Indian rupee will reach the level of 82 by the end of 2022 due to ongoing global market instability.
“However, we see tails risks of larger depreciation contained by RBI’s ample reserves buffer,” he said.
