The Indian rupee’s persistent decline against the US dollar has been a topic of concern for policymakers, investors, and the common citizen alike. In recent weeks, the rupee has hit record lows, plunging to 85.97 against the US dollar and breaching the psychologically significant 86/$ mark. This sharp fall places the rupee at the forefront of global currency declines. Let’s delve into the key factors driving this depreciation.
1. Strengthening US Dollar
The US dollar has shown remarkable resilience, with the dollar index - which measures the greenback against six major currencies—climbing to 109.72, its highest level in over two years. Robust job growth in the US has fueled expectations that the Federal Reserve may slow down its rate cuts. This has strengthened the dollar further, putting downward pressure on emerging market currencies, including the rupee.
2. Surge in Crude Oil Prices
India, being a net importer of crude oil, faces significant challenges when oil prices rise. Brent crude recently surged by 1.44% to $80.91 per barrel. Higher crude oil prices widen India’s trade deficit, increasing demand for dollars to pay for imports and exerting additional pressure on the rupee.
Dependence on oil imports remains unchanged, with every $1 increase in oil prices widening the trade deficit. Over the past decade, India’s trade deficit has ballooned. In FY23, it hit $122 billion, one of the highest ever.
3. Foreign Fund Outflows
Foreign institutional investors (FIIs) have been pulling out funds from Indian markets, exacerbating the rupee’s woes. On January 10, FIIs sold equities worth ₹2,254.68 crore. Over $3 billion has been withdrawn from Indian stocks and bonds so far in January, further straining the rupee’s stability.
4. Weak Domestic Market Sentiment
Domestic equity markets have mirrored global weaknesses, contributing to the rupee’s decline. The BSE Sensex dropped by 550.49 points to 76,828.42, while the Nifty slid 182.45 points to 23,249.05 during early trade on Friday. Weak market sentiment often prompts investors to seek safer assets like the US dollar.
5. Declining Forex Reserves
India’s forex reserves have seen a steady decline, falling by $5.693 billion to $634.585 billion in the week ending January 3. Lower reserves reduce the Reserve Bank of India’s (RBI) ability to intervene effectively in the forex market to stabilize the rupee. Despite having one of the world’s largest foreign exchange reserves (over $600 billion), this has not shielded the rupee effectively.
6. Inflation and Fiscal Deficits
Internal issues such as persistent inflation and fiscal deficits are adding fuel to the fire, making the economy vulnerable. A significant portion of the reserves is being used to stabilize the currency rather than investing in structural growth.
What Role Does the Reserve Bank of India Play?
The Reserve Bank of India (RBI) routinely intervenes in the forex market to curb excessive volatility in the rupee. On Friday, state-run banks were spotted selling dollars, likely on behalf of the RBI. However, interventions can only do so much when external factors like a strong US dollar and high crude oil prices dominate.
Historical Patterns
The rupee’s struggles are not new. Over the years, it has faced several challenges:
- 1991: India pledged 67 tons of gold to secure an IMF loan as forex reserves dried up, kickstarting liberalization.
- 2013: The “Taper Tantrum” saw the rupee tumble to ₹68 as foreign investors pulled out.
- 2020: The pandemic pushed the rupee past ₹76 amid inflation and a liquidity crunch.
A pattern emerges: high trade deficits, rising crude oil prices, and foreign capital outflows during global uncertainty have been recurring triggers. Every major rupee dip correlates with a global economic shift.
Is a Fall Below 86 Inevitable?
With the rupee already flirting with the 86/$ level, many traders believe a breach is just a matter of time. Options pricing indicates that the rupee could weaken further, possibly dropping to 88 in the medium term and even hitting 90-92 in the next 6-10 months. According to ING Bank, robust US jobs data could push the first fully-priced Federal Reserve rate cut beyond June, bolstering the dollar even further.
What Does This Mean for India?
A depreciating rupee impacts the Indian economy in several ways:
- Increased Import Costs: Higher costs for imported goods, particularly crude oil, can lead to inflationary pressures.
- Wider Trade Deficit: A weaker rupee increases the trade deficit, as imports become costlier.
- Pressure on Businesses: Companies reliant on imports or with significant foreign debt face rising costs, affecting profitability.
- Impact on Consumers: Everyday goods—from smartphones to fuel—will see price hikes, straining household budgets.
- Study and Travel Abroad: Studying abroad will become more expensive, and Indian companies with foreign debts will face mounting repayment burdens.
Lakshmi Iyer, CEO of Investment & Strategy at Kotak Alternate Asset Managers, emphasizes the need for pragmatism in navigating these challenging times. “Look at crude oil prices. They clearly put further pressure on our trade deficit. Near-term constraints are unavoidable. However, given that the rupee has depreciated less than others over the past year, some payback is inevitable,” she said.
Moving on, the rupee’s performance will largely depend on global market trends, oil price movements, and domestic equity performance. Forex traders warn of continued volatility, with the dollar expected to remain strong in the near term. Policymakers need to address both external and internal factors to stabilize the currency and ensure resilience against future shocks.
Meanwhile, external factors like uncertain U.S. trade policies, Fed rate hikes, and leadership transitions could add volatility, with the RBI allowing market-driven currency adjustments.
While the current outlook appears bleak, a balanced approach by the RBI and government, along with structural economic reforms, could help mitigate long-term risks.
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