More uncertainty with rupee’s slide

Last Tuesday, the commerce ministry said the trade deficit for July was estimated at a little above $18 billion, as against one of nearly $11.5 bn during July 2017. On the same day, the rupee depreciated to around 70 to a dollar, weakening by almost 1.9 per cent in only two trading sessions. On Thursday, it fell further, before a modest recovery on Friday morning.

The rupee’s depreciation was partly due to global turmoil in currency markets. Turkey’s lira lost around 40 per cent and all emerging market currencies bore the brunt of money flowing to safe havens in the United States. However, the rupee has also been weakening since April due to several factors — monetary policy tightening by the US Federal Reserve, rising crude oil prices, weakness of the Chinese yuan, deteriorating fiscal position, lacklustre export performance, a widening trade deficit at home, political uncertainty ahead of next year’s election and so on.

In the past four years, the real effective exchange rate of the rupee, as measured by the Reserve Bank’s 36-country index of trading partners, had appreciated by almost 20 per cent. It has since depreciated by about eight per cent. To that extent, the correction is a welcome development. In theory, this should help exporters, especially those with low import intensity. In reality, services exporters will benefit through higher rupee realisation but merchandise exporters might gain less due to demands for price reduction from buyers, especially when currencies in the competing economies have also depreciated as much.

Import will get costlier, giving producers some leeway to increase their market share in the months ahead and increase their capacity utilisation. Import of goods other than oil and gold have been growing in the past few months, due to revival of consumption and investment in the domestic economy. So, import might continue to rise due to higher consumer demand in the festive season, more buying of capital goods to augment capacity and higher commodity prices.

Thus, it is far from certain that export will get such a solid boost or that import will fall so dramatically that the trade deficit will come down significantly. However, the current account deficit might go down due to private inward remittances and services export.

Revenues from customs duties and integrated goods and services tax on import might go up due to higher rupee values of imported goods, helping the government cope with a worsening fiscal deficit. However, worries persist that the gains might be frittered away in the election year through spending on populist schemes.

The higher price of crude oil and the falling rupee, coupled with looser fiscal policy, might have inflationary impact. Keeping its statutory mandate to rein inflation in the four to six per cent range, the Reserve Bank might raise interest rates. Thus raising borrowing cost and impacting the revival of economic growth. Meantime, companies that have borrowings in foreign currency and mostly domestic sales will find debt servicing more difficult. Students going abroad for higher studies and families going abroad on vacations will have to pay more.

Overall, volatility in the markets has gone up and the economy’s pace of revival could get slower.