A change in the rupee value of the dollar by Re 1 sets new benchmarks in the market and the question asked is whether it will cross the next threshold. It happened when the rupee crossed Rs 72/$ when the market was abuzz with talk of Rs 73/$. Now that it has crossed Rs 73/$, speculation is on when the Rs 74/$ mark would be breached. Curiously the reference rate has been between Rs 72-73 for 14 trading sessions which is probably the longest period when the rupee stayed in range of Re1/$.
The Rs 71-72 range was maintained for 4 sessions while the 70-71 range prevailed for 8 days and Rs 69-70 for 4 days. Will the present Rs 73/$ mark be the new base or will the exchange rate revert to Rs 72-73 range?
The honest answer is that no one can tell, gauging by the factors that have been driving the rupee in the last couple of months. The weak fundamentals as reflected in higher imports, current account deficit and declining reserves have often been the arguments that have been put forward when trying to ascertain some pattern in the decline in the rupee value.
However, if we look at the measures announced by the government to stabilize the rupee and analyze the impact, then it appears that we may be barking up the wrong tree.
The government has done two things sequentially while the Reserve Bank of India (RBI) has been trying off and on to stabilize the rupee. First, the government had announced measures to bring in more capital flows and policies and was directed at Foreign Portfolio Investment (FPI) and External Commercial Borrowings (ECBs). This did not work. Subsequently, the government announced an increase in tariffs on certain non-essential imports, which did not look very significant to begin with.
However, the announcement effects were negligible. Quite evidently the problem was not here. The RBI has all along been intervening selectively in the market by selling dollars to stabilise the rupee. So far around $16 billion has been sold; yet the rupee continues to move downwards.
What then has been driving the rupee? The answer is global factors. Presently there are two major worries which have made the dollar stronger and rupee weaker. The first is the oil crisis in terms of the sanctions on Iran which get invoked from 4 November. The exact impact is not known but for a country like India which imported around half a million barrels per day from Iran in the first quarter, the sanctions become significant.
Iran is the second highest supplier of oil to India. With crude oil prices touching the $85/barrel mark and likely to remain in an upward trajectory, the budgetary assumption of around $65-70/barrel has been passed on a permanent basis. The uncertainty of future supplies, as well as volatile oil prices, have added to the rupee weakness. In fact over 23 August when the rupee crossed the Rs 70/$ mark, it was the weakest performing currency among other major countries barring Argentina.
The other factor is the ongoing trade war between China and USA. The imposition of higher duties by US on Chinese imports cannot be countered on an equal plane by the latter as China exports more than it imports from USA. This has kept the US dollar stronger in the global market and the weakening rupee is a resultant of these trade waves.
If one were to single out the main factor, it would be oil as the external vulnerability would hinge more on what happens to our imports which will be driven by the POL basket.
Also the fact the Federal Reserve has increased rates once again and pointed to one more hike this year would be a dampener for FPI flows which are in the negative terrain in both equity and debt.
Two important time points which will be crucial here would be 5 October when the RBI announces its credit policy where a view is taken on the external situation and an indication given on what the central bank feels about the same. Also the action on interest rates become important and a rate hike is almost necessary to ensure that there is some parity maintained from the point of view of capital flows.
The second time point would be almost a month later when the sanctions on Iran kick in. This will have a bearing on both the international price of crude oil as well as the way in which India manages its imports. Therefore, a volatile exchange rate may be expected to rein in the next month or so.
Can the RBI do anything? Probably not, as selling dollars can cool the rupee in specific trading sessions only and it will be sentiment-driven subsequently. Putting curbs on oil imports is probably theoretically an option but cannot be implemented as it will create chaos in the domestic market. Besides quantitative restrictions are passé post-WTO.
It can be hoped that there will be some corrections once the November deadline passes and the rupee regains some lost ground. The oil price will matter and in case it does move towards 90 and further to 100, then there would be a serious problem on hand.
First, the Current Account Deficit (CAD) will overshoot and reserves will tumble further in case capital flows do not compensate for this fall. In such an eventuality a bond/deposit issuances would probably be called for to stem the decline in rupee. Otherwise, inflation would soar as the government is not willing to relent on the tax collections at this end. This is probably an extreme situation and needs regular monitoring with plans drawn up to get in forex capital in case required.
(The writer is Chief Economist, CARE Ratings; and author of Economics of India: How to fool all people for all times)
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Updated Date: Oct 04, 2018 07:29:23 IST