Rupee hits all-time low of 69.13 per dollar: As external shocks loom large, here's how RBI can save the free-falling unit

The rupee continues to stumble and fall and if we are to go by the futures prices, the number looked at as of March 2019 is close to Rs 71 against the US dollar. The pace of decline appears to be faster than expected and more importantly the rupee is getting more volatile. With the fundamentals and sentiments being uncertain it looks like that volatility is here to stay. The question is for how long?

Our forex reserves have fallen by around $ 18 billion since March end and the Reserve Bank of India (RBI) has been active in selling dollars of around $ 8 billion to stabilise the rupee at various point of time. There is already concern in the government that this issue can escalate which can ironically be deduced from the fact that it is being reiterated that we have enough dollars to protect the balance of payments. This is assuring.

Let us look at the global factors that will continue to weaken the rupee by making the dollar stronger. This is a common factor affecting all global currencies. The trade war threats are still on and the USA is quite aggressive on tariffs on Chinese imports as well as sanctions on Iran. This will be a factor that will make global markets shaky and until these measures take final shape it will keep currencies volatile.

Second, the Fed will be increasing rates and this is inescapable despite the US President Donald Trump not being supportive. Indications are that there could be 3 more hikes this year which is making the dollar stronger. The government‘s focus on more spending and cutting taxes implies higher deficits and more demand which is inflationary and will be countered by the rate hikes. This is also a certainty.

Third, the crude oil picture looks unsteady. While crude prices have come down to less than $ 74/barrel, the future direction is uncertain. The shortfall in production is one issue but once the movement of oil supplies from Iran stop, which will be towards the end of the year, the prices are bound to spike as this would also be the winter season when demand picks up. US shale oil will not be able to fully compensate for this decline.

 Rupee hits all-time low of 69.13 per dollar: As external shocks loom large, heres how RBI can save the free-falling unit

Representational image. News18

Another external factor that would be playing in the background would be the political issues especially Brexit and the future of the European Union. This would be a secondary factor which nonetheless will move the global markets.

Closer to home, the political sentiments will also play out. With several state government elections around leading to the general elections next year the waves of voting conjectures will also influence the exchange rate just like how the news of a vote-of-confidence affected the rupee in the last couple of trading sessions.

The fundamentals continue to remain fragile. The latest trade numbers show that the deficit has widened in the first quarter from $40 to $45 billion. More importantly, this will be the trend going forward. Imports will keep rising as long as oil remains volatile and any recovery in the industry which is expected will lead to higher imports. Exports too are growing but not at the same pace and hence there will continue to be pressure on the rupee.

Second, Foreign Portfolio Investments (FPIs) have been negative all through, which is a concern. The RBI had widened their scope of operations by allowing greater scope for them. However, with interest rates rising in the USA and the rupee becoming volatile, a vicious circle has emerged where higher outflows of FPI weakens the rupee which in turn makes investments in India less attractive as the forex risk increases.

Other flows need to increase to counter these two negative flows, which is not happening. Invisible receipts including software and remittances are two major supports for the balance of payments and have to increase more than proportionately to offset the decline on the trade and FPI fronts. Similarly, while ECB proposals have increased, they need to materialise to bring in the dollars. The weak rupee may defer these borrowings as domestic sources could be more attractive.

What can the RBI do in such a situation? The first is to sit back and do nothing. But this is risky as it can lead to a speedier fall in the rupee. Second, it can start selling dollars in the market. But there is a limit to the sale as expectations will always increase. Third, it can deal in the forwards market, which it has done so far. This sends a strong message. Fourth, at some stage it could consider doing what was done last time like raising bonds or getting in more NRI deposits. This can shake the market as it has been maintained all along that the regulator was not too concerned about the exchange rate and making such an announcement will indicate the acceptance of problems. This can hence be the last resort. Fifth, there can be restrictions put on forex outflows as was done earlier where exporters may be asked to bring in all their earnings and restrictions put on some current outflows. This though not advisable will be effective in the short run.

Ideally, the RBI should allow the rupee to fall especially so as other currencies too are declining against the dollar. Depreciation of around 4-5 percent per annum is not unusual and given that we have had periods of the rupee getting stronger, such a decline will help to restore equilibrium. The rupee looks very likely to cross the Rs 70 against the US dollar mark and we must be prepared for this.

A worry for the central bank, however, is inflation as weaker rupee increases prices of imported goods and adds to inflation, which is on the rise. This may not hence be acceptable and probably this is why there has been intervention through the sale of dollars to stabilise the currency. Besides, there is a high risk for both debtors and importers whose costs would go up in the absence of hedging. This is another worry for the RBI. And this is why there has to be further action taken to remove the noise element in the currency and keep it on a stable path.

(The writer, chief economist, CARE Ratings, is author of 'Economics of India: How to Fool all people for all times')

The Great Diwali Discount!
Unlock 75% more savings this festive season. Get Moneycontrol Pro for a year for Rs 289 only.
Coupon code: DIWALI. Offer valid till 10th November, 2019 .

Updated Date: Jul 20, 2018 16:47:41 IST