The rupee was in a remarkable state of somnolence for quite some time until August, but September has turned out to be the turning point. It crossed the 46 mark and since then has been falling or numerically increasing to cross 52 to reach an all-time high level in November. When the decline started, the number of 50-plus was not really conceivable, but now one cannot be sure as the value has changed by R6 to a dollar in less than three months. The questions that come up are: why is the rupee falling, where will it go, can anything be done about it and should we be concerned.
Let us look at the why of it. There are three sets of reasons behind this phenomenon. Our balance of payments fundamentals have been under some pressure, though the net outflow of around $6bn in the last three months cannot justify this large movement in the exchange rate. On a monthly basis we know that our trade balance has widened and the quarterly current account deficit has come under pressure. But it is the capital account that is creating problems here, as FII inflows have slowed down and turned negative on several days. Higher FDI inflows have not been able to compensate for this outflow, resulting in overall lower capital inflows. ECB borrowings have been popular and rising, but once the exchange rate starts depreciating, the exchange risk increases commensurately, and their attractiveness diminish. This is one part of the story.
The second set of factors that has accelerated the process of depreciation is that the dollar has strengthened against the euro as the euro crisis deepened. One may recollect that when the US was under pressure in late July and early August, the dollar took a beating and the rupee gained from it. However, with the world now accepting the strength of the dollar, it has moved up against the euro to now be in the region of $1.35 to a euro. This has added to the rupee?s woes.
Now, when the fundamentals are weak or shaky and the dollar is strengthening in global currency markets, the third factor comes in, i.e. sentiment. There is a rush for dollars as importers want to buy dollars to cover their imports, exporters prefer to hold back their earnings, while debtors try and pick up dollars to service future debt. There is around $20bn that has to be paid this year. This has exacerbated the demand-supply imbalance, driving the rupee down further.
Where will the rupee go? The honest answer is that one does not know.
Based on information available, it looks like that it has to go down further as exports will not turnaround and FII flows will remain weak at least until December end. In the absence of any intervention, the rupee should move further down.
This leads to the next question about if anything can be done about it? Those being adversely affected should logically have been hedging their forex risk either in the OTC or derivatives markets. Today there are products available on exchanges like the NSE that provide scope for such cover. But, more importantly, RBI has a role to play here. The stance so far has been fairly neutral, which, in turn, tells the market that it is satisfied with the current developments. RBI can take some affirmative action and there are two options to provide direction. The first is to actually provide dollars in the market, which will help curb sentiment and panic purchase. The other is to make strong statements, which is probably a more effective tool. Based on its independent analysis on the subject of rupee depreciation, RBI should explain the rupee movement and give a target exchange rate that is within its comfort level. This will guide the market and automatically gravitate it towards equilibrium. Today no action is interpreted as acceptance of the current trend.
To the last question about whether or not we should be concerned, the answer is yes. Exchange rate movements are part of the market, but such swings in the rates and high volatility creates distortions. Given that such swings are more pronounced than in other currencies and that our fundamentals are still satisfactory, we need to be worried. Exporters may cheer now, given that there is an advantage to be had in global markets. But importers and debtors are obviously not pleased. And, more importantly, at the macro level, a falling rupee has not allowed us to enjoy the benefit of declining global commodity prices, which means that imported inflation has not come down. Surely, one should expect some RBI action, which appears to be the only answer in this market.
The author is chief economist, CARE Ratings. These are his personal views