Weak Indian rupee likely to slow growth

Rising dollar and oil have hammered the currency, and it is unwise for the central bank to interfere

The Indian rupee slumped to a historic low of 71 to a dollar on Friday as the country’s economy grew at a stunning 8.2 per cent in the first quarter of the 2018-2019 financial year. Key stock indices are also hovering around record highs. So, India’s macroeconomic fundamentals can’t be blamed for the rupee woes. It’s a confluence of external factors that are hammering the currency.

In recent months, the US dollar has been gaining strength across a basket of currencies. Bond yields are also rising, as the US economy gathers momentum, pointing to a further rise in inflation and interest rates. Additionally, emerging market currencies have been on a downhill ride on fears of a contagion from financial crises in Argentina and Turkey.

For India, excessive dependence on oil imports is its Achilles heel in foreign exchange management. When the country imports 70 per cent of its crude requirements, any rally in oil inflates the import bill and impacts the currency. And crude prices have risen from $65 (Dh239) to $80 after United States President Donald Trump scrapped the Iran nuclear deal.

The rise of dollar and oil together has come as a double whammy for the rupee. The slump in the currency and the resulting jump in oil import bills will increase India’s current account deficit, threatening the country’s balance of payments.

The sharp decline in foreign portfolio investments into the country has also added to the woes. Overseas investors had pulled out more than $8.5 billion during April-June in the wake of the surge in crude prices and fears over a rate hike by the US Federal Reserve.

Although the Reserve Bank of India made some sporadic but unsuccessful interventions to limit the rupee’s losses, the currency has lost about 10 per cent this year. India currently holds $400 billion in forex reserves, but it is neither wise nor desirable for the central bank to intervene in the forex markets to prop up the rupee. For, it does not take much time to wipe out the reserves in a speculative onslaught.

The rupee is unlikely to recover swiftly, and policymakers will be inclined to seek solace in the strong gross domestic product numbers. But when the currency is weak, the growth rate can only be expected to be moderate as private investment will be stifled by stressed assets, rising inflation and high interest rates.