A year ago, hit by the problem of widening twin deficits, the rupee had plunged 12% in just three months to its all-time low of 57.33. Currency experts believe a test of those record lows is now in the offing.
It would seem that we are looking at new lows now. The dollar is going to strengthen, which means all other currencies including the rupee will weaken, said Jamal Mecklai, MD of Mecklai Financial Services.
The strength in the dollar has pushed most emerging market currencies lower but the rupee is among the worst performing currencies over a one-month and three-month period. Only the South African rand and the Brazilian real have weakened more than the rupee.
While equity inflows have been exceptionally strong, hitting $15 billion so far this year, there has been a reversal of flows in the debt markets. In the first four days of this month, foreign institutional investors have net sold over $1 billion worth of debt due to the narrowing interest rate differential between Indian debt and US debt.
US treasury yields on its benchmark 10-year bond are trading near a 30-month high at 2.05%, a rise of 40 basis points in just a month. The Indian 10-year government bond yield was 7.23% on Friday.
Most emerging market currencies have been hit by the worry that the US Federal Reserve will reduce the pace of its quantitative easing programme, which in turn could mean that incremental foreign portfolio flows into economies like India may slow, analysts said. The quantum of global liquidity for emerging markets is shrinking and, therefore, there is a repositioning in the market, said Abheek Barua, chief economist at HDFC Bank.
Adding to the rupees fall on Friday were comments made by Reserve Bank of India governor D Subbarao, which seemed to unnerve an already jittery market. Hinting that the RBI may not be in favour of intervening strongly to stem the fall in the rupee, Subbarao said, "The important point is that we have to be internally sure that when we enter the market we are credible because for a central bank a failed defence of exchange rate can be quite detrimental.
While the governors comments were made in an academic context in Hyderabad, it raised familiar fears that Indias forex reserves of under $290 billion are now only enough to cover roughly 7 months worth of imports. Incidentally, weekly data released by the RBI on Friday showed that foreign exchange reserves fell by over $4 billion to $287.9 billion as on May 31, from $292 billion in the previous week.
According to Mecklai, the RBIs show of nervousness is adding to the pressure on the rupee.I think they need a lesson in poker, he said.
As the rupee tumbled in the afternoon session, public sector banks reportedly sold dollars in the forex market. Such sales were attributed to the central bank intervention although it was not clear whether the central bank did step in.
Dealers said that even in instances of intervention, it seemed mild in the least.
On Thursday, finance minister P Chidambaram tried to calm the markets by saying that the fall in the rupee was no cause for alarm.
The sharp fall of the rupee could put many Indian companies at risk as a large part of their debt is unhedged. RBI deputy governor HR Khan had recently said that 60% of corporate debt is unhedged. As on December 30, 2012, outstanding forex loans of companies was $112 billion and between January and April, companies have raised another $12 billion through offshore loans.
If a companys revenues are not linked to the exchange rate but it has a huge unhedged debt, then we need to be worried. Otherwise, there is no big threat from the rupee depreciation, the treasury head at an IT company said.
The weaker rupee may also result in a higher outgo for importing companies such as oil marketing firms. However, currency dealers say that much of these needs would be hedged. Oil importers are not going to buy big volumes henceforth because many of them have already hedged their positions, said a currency dealer.
"The weakening of the rupee will naturally be a negative for us since we have to pay more to get dollars. But this may stabilise after sometime as the RBI could step in. We do not have any particular expectation of the currencys direction," said KV Rao, executive director (finance) at Hindustan Petroleum.
While importers may face a downside from the depreciating rupee, for exporters including IT firms the weaker rupee could be a marginal positive. "Clearly, a weaker rupee improves our margins. Margins improve by 30 bps with a 1% depreciation in the rupee." said Sonjoy Anand, CFO at Tech Mahindra.
While the Indian currency has been under pressure due to the record high current account deficit, some comfort has been derived from the strong inflows of foreign capital into the equity and debt markets in 2012 and the first five months of 2013. However, some fears have emerged that the pace of fund flows could drop or even reverse as incentives to invest in India are reducing due to weak domestic growth and changing global sentiment.