Oil screeched higher a week after the invasion of Ukraine, rising about 30% to over $130 per barrel. Many other commodities followed suit—nickel, the wildest of the bunch, rose by more than 100%; aluminum, already rising, climbed a further 20% to a 20-year high; copper, a bellwether for big changes, was quiet, rising only 9%. Fortunately, the peaks were extremely short-lived with all metals turning sharply lower to where they are today—between 5% (nickel) and 25% (aluminum) below their prices at the start of the invasion.
Oil, on the other hand, remains high—at $116 a barrel, it is still 15% higher than it was at the time of the invasion—and shows no signs of coming down. This makes it the prime villain of the piece because high oil prices keep global inflation high, which keeps US rates high that, in turn, keep the dollar strong, pressuring the rupee and all other currencies.
The impact on the rupee is, of course, there for everyone to see. With US interest rates rising and RISK-OFF blinking loudly in world markets, portfolio investors have been leaving our market in droves—since the start of the Russian invasion of Ukraine, over $22 billion has been pulled out, the vast bulk of it from equities. Significantly, the outflows have been single-minded, with outflows on 63 out of the 79 days (82%) since the invasion. In normal circumstances, inflows and outflows are much more balanced; over most periods, there are generally a more or less equal number of inflow days and outflow days (49% outflow days since January 2021).
Clearly, the outflows are much more determined today, and, of course, are reflected in the pace at which the reserves are falling. The accompanying graphic shows the 4-week and 14-week averages of the weekly change in reserves since 2021, which indicates that reserves are falling at an accelerating pace. Since September last year, the reserves have fallen by a little over $50 billion, about as much as they fell between May and November 2008; at that time, $50 billion represented about 16% of our reserves, which resulted in huge instability and an 18% fall in the rupee. Today, 16% of our reserves would be closer to $100 billion.
And while we are some ways from that, the reserves are already lower than $600 billion for the first time since June last year, and foreign currency assets (part of the reserves), at $526 billion, are at the lowest they have been since October 2020. Another $20 billion or so of declines in the reserves would increase the pressure on RBI many fold—recall that an 18% fall of the rupee from September’s level of around 73 would take it north of 85. [I note that history doesn’t ever repeat itself exactly and there’s no telling whether reserves will fall by that much or even if they do whether the rupee will fall by that much; it’s just useful to keep history in focus.]
There are several analysts who believe that RBI should allow the rupee to depreciate since it appears to be a fait accompli. I have generally felt that RBI’s approach of trying to keep the rupee on a relatively even keel is a better way, since inflation is clearly the most significant threat, both globally and in India. Global markets are still on the boil—the Dow continues to track its own 2008 shadow with a correlation of 70+%, and, as already mentioned, oil (like Putin) is showing no signs of retreating meaningfully. As a result of this, the US Fed is on track to ramp up rates sharply (and, likely, more sharply than they are letting on or even believe right now); to be sure, the US economy is already showing signs of recession and there are already calls for the Fed to ease up. That would be foolhardy—once inflation is triggered, giving it any chance to relapse just stores up pain for longer.
Thus, I feel the pressure on RBI’s rupee support operations will only increase. Perhaps, another out-of-turn rate hike is the order of the day—tomorrow rather than the morning of the next Fed meeting. That may surprise the market enough to give the rupee some breathing room and a little upward momentum, even if it turns out to be temporary. Hold on tight.
The author is CEO, Mecklai Financial. http://www.mecklai.com