Brave, New World Of Falling Rupee
The rupee has slipped by around 7.5 per cent against the dollar over the last six months. Multiple factors have contributed to the recent depreciation of the currency. Tighter oil supplies, geopolitical tension and US sanctions on Iran have sent global crude oil prices soaring and bloating India's dollar demand.
Huge dollar purchases by oil importing companies, along with speculative activity, have largely weighed on the rupee. Indian importers have rushed to purchase oil which is in short supply. This has caused the value of the rupee, which is used to purchase the dollars required to buy oil in the international market, to fall.
Besides, trade war tension has sent some capital deployed in emerging markets back to the US. This reflects investors' traditional flight to safety in times of uncertainty. Moreover, tightening of monetary policy by the US Federal Reserve has caused the price of American debt to fall and yields to rise. This, in turn, has also pushed investors to pull money out of India and other emerging market economies to invest in the US, where they can get higher returns.
The rupee's fall has raised fears of a repeat of the currency crisis of 2013 when the currency suffered a drastic loss of about 20 per cent in just a few months. Though the slide this time too has been largely triggered by global cues reminiscent of the taper tantrum episode in May 2013, the depreciation in 2018 has been far more orderly.
The financial markets appear to be taking comfort from the fact that India's macroeconomic fundamentals today are in far better shape to handle external shocks than they were in 2013. Despite the rising import bill, the country is expected to run up a Current Account Deficit (CAD) of 2.5 per cent of GDP in FY19, far lower than the 4.8 per cent in FY13.
Thanks to its stockpiling of dollars over the last two years, the RBI's foreign currency reserves at a little over $400 billion provide import cover for nearly 10 months compared to barely seven months in FY13. But policy-makers cannot afford to relax their vigilance. The fundamental macroeconomic indicators can deteriorate very quickly indeed in the event of a run on the currency.
In fact, a sliding rupee can set off a vicious cycle on the CAD and inflation numbers. Foreign portfolio investors (FPI) are known to react in a knee-jerk fashion to dwindling dollar returns. The RBI has tried to pre-empt such outflows by raising the FPI ceiling for bonds and relaxing its residual maturity conditions. But then, India's FPI flows in the last couple of years have featured a lot of hot money chasing rate differentials.
Many analysts note that for some time now, the rupee has been significantly over-valued on a REER (Real Effective Exchange Rate) basis relative to its trade partners. India's foreign exchange reserves cannot be squandered on defending a rate that is at variance with market reality. So, the RBI can intervene only to smoothen out volatility in the currency and not to peg the rupee to a particular rate.
Given the circumstances, it is best that the RBI allows an orderly correction of the exchange rate. It should step in with market interventions only if there is the need to fend off speculative volatility. This is exactly what the RBI is doing as the rupee keeps falling gradually. Perhaps it is now time to say goodbye to the panic surrounding the weak rupee. Welcome to the brave, new world of Rs 68 to a dollar, and this seems to be the new normal.
Many analysts note that for some time now, the rupee has been significantly overvalued on a Real Effective Exchange Rate basis relative to its trade partners. India's foreign exchange reserves cannot be squandered on defending a rate that is at variance with market reality. So, the RBI can intervene only to smoothen out volatility in the currency and not to peg the rupee to a particular rate.
Despite eerie similarities with the fall of 2013, the rupee's slide this time is not disconcerting.