The rupee is facing turbulent weather because of the impact of both global and domestic issues. The domestic currency has declined 9 per cent over the last seven months to a 13-month low of 63.53 against the dollar by Tuesday, exposing the soft economic underbelly of the government after the NDA won the polls in May. George Mathew explains the reasons for the rupee’s slide and its impact.
Why is the rupee falling at a time when inflation is cooling off and growth is projected to be higher next fiscal?
Firstly, the sustained fall in crude oil prices to a five-year low has led to concerns over global growth, prompting a sell-off in emerging market currencies. Russia raised its key interest rate to 17 per cent after the ruble sank to record lows amid plunging oil prices. China’s factory production index is at a seven-month low. Neelkanth Mishra, MD (equity research), Credit Suisse, says FII inflows will halve to $10 billion next year if this trend continues as sovereign wealth funds, who have built huge surpluses because of oil prices remaining high, may now retreat.
Exports are also under pressure — it fell 5 per cent in October and rose 7.3 per cent in November on a low base. India’s trade deficit widened to an 18-month high as gold imports rose almost seven-fold to $5.61 billion in November. Higher imports mean more foreign exchange outgo and a weak rupee. All this could spell a widening of the current account deficit (CAD) — the excess of imports over exports. The strengthening of the US dollar has also caused an element of volatility in the currency market.
Will the rupee decline further?
If imports — read gold imports — rise further and capital inflows decline, the Indian currency will move downwards. If the CAD widens, it could impact the rupee negatively. If global growth falls, exports could falter which will be bad news for the rupee. Further, if the US raises interest rates in mid-2015, there will be ramifications across emerging markets which could see money flowing back to the US, in search of higher yields, impacting the rupee negatively.
What’s the impact of a weak rupee?
In a normal scenario, a weak currency should benefit exporters as their income will rise on conversion of their income from dollars to rupee. But as exports are under pressure due to low oil prices and slowing global growth, this time it may not help the rupee much. Major oil producers, who are also big consumers and importers, are finding their incomes shrinking. Importers will find it more expensive to import goods as they will need more rupee buy dollars. With a perennial CAD, India will see its import bill rising. In short, lower exports and a higher import bill can derail India’s external finances. Stock markets are also uncomfortable with a
What can the government and the RBI do to address this?
The government, which is struggling to meet its fiscal deficit target of 4.1 per cent won’t be able to cut Customs duty to reduce its import bill. However, it can liberalise the FDI levels in various sectors and attract more inflows. Curbs on gold imports are an option too, but that hasn’t worked much in the past. The RBI can prevent a steeper slide of the rupee by selling dollars from its foreign exchange reserves of $315 billion to stabilise the currency. But that would mean depleting forex reserves. In 2013, when the rupee plunged to a record low of 68.80, the RBI tightened domestic liquidity, raised short-term interest rates and slapped curbs on speculation in the currency market.
What will be the impact on the rupee if the RBI cuts interest rates now?
A high interest rate regime will help the rupee indirectly. With an expected rise in interest rates in the US, there is a high probability of a significant decline in demand for rupee from FIIs in the short run, leading to a further depreciation. In this context, the RBI’s decision to not cut rates may help reduce the volatility in exchange rate for a while till there is more stability.
Is a weak currency good for economy?
A prolonged weakness is not good for the economy. However, depending on overall economic fundamentals, especially for a country which consistently has been running trade and fiscal deficits, the government and the RBI have been allowing the rupee to slide a bit so that it helps provide a boost to exporters. But a sustained weakness in the absence of a good forex buffer can push up cost of goods and even impact exports. Similarly, a strong rupee could also hurt the economy. Policy makers will have to strike a fine balancing act.