Rupee at 51: Will Asia's worst currency continue falling?

What a volatile week it has been for the rupee.The partially convertible currency hit 51 against the dollar early on Friday, after closing at around 50.90 per dollar on Thursday.

It’s a 33-month low for the currency and the consensus is that the rupee will keep sliding for a while due to a combination of unfavourable global and local factors.

One of the most pessimistic predictions issued yesterday was by Laurence Balanco,technical analyst at CLSA. He told CNBC TV-18 the rupee could dive all the way to 58 against the dollar if it fell to the 52 mark.

While that might seem a little extreme, the fact is most experts believe the rupee’s slide is set to continue, at least in the medium term.

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[caption id=“attachment_133972” align=“alignright” width=“380” caption=“That the rupee is falling against the dollar is no surprise. Reuters”]  [/caption]

According to The Wall Street Journal, the Indian rupee is the world’s third-worst performing currency this year, falling by nearly 14 percent , next only to the Turkish lira, which is down 17 percent and the Kenyan shilling, which has lost 15 percent.It is also Asia’s worst-performing currency, the newspaper added.

What’s happening to the rupee?

The reasons for the rupee’s slide are not difficult to understand.

One, the never-ending sovereign debt travails of the eurozone continue to keep global investors on edge, who, as a result, continue to pull money out of relatively riskier emerging market assets and dive into safe havens like the US dollar. Indeed, some experts have said there is an increasing scarcity of dollars in the currency markets, given that everyone is scrambling to play it safe.

Two, a slowdown in the local economy, coupled with high inflation, is muting the prospects of corporate earnings, which is putting off foreign investors. Higher demand for local assets typically boosts demand for the local currency and thereby leads to the currency’s appreciation.

Foreign investors have only bought $663 million worth of Indian equities this year, sharply down from the $29 billion they invested in 2010, according to data from the Securities and Exchange Board. Not surprisingly, the benchmark Sensex is also down 20 percent this year. Capping the bad mood wasShankar Acharya, former chief economic advisor to the government, warned the economy could expand below 7 percent in the year ending March 2012. Other economists believe growth could be between 7-8 percent.

Three, India remains a net importer of foreign goods, and a third of that consists of oil imports. According to TV reports, oil companies import about $6 billion worth of crude every month.

A falling rupee will increase the cost of imports (in local currency terms), which increases the current account deficit, which is the trade deficit plus interest payments and other transfers. The trade deficit is the difference between exports and imports.

The current account deficit can be funded either through foreign direct investments or foreign portfolio investments (in equity/debt markets). But as we all know, foreign investments in local assets such as stocks have been low. Meanwhile, the current account gap continues to widen, which worries investors.

Four, with foreign currency reserves of $311 billion (at the end of September) and imports worth about $35 billion for the month, India now has the lowest import cover of 8-9 months. This is the lowest in the last decade, according to an opinion piece in Business Line. That worries investors because with the increasing cost of oil imports, there will be further demand for the dollar, which should drive down the value of the rupee further.

Five, hopes that the Reserve Bank of India (RBI) will intervene in the foreign exchange market to boost the rupee have dimmed after Deputy Governor Subir Gokarn said earlier this week that the central bank did not plan on changing its policy of intervening in foreign-exchange markets only in times of excessive volatility. That means investors can’t expect the RBI to swoop in and lift the rupee every time it hits a new low against the dollar.

All things considered, expect the rupee to keep going downhill for a while.