With the rupee on a slippery slope, the weak currency is causing more pain than gain. The Board of India Today Experts prescribes a slew of measures to prevent further devaluation of the rupee and keep the country’s growth momentum going
Q. What do you attribute the fall of the rupee to?
N.R. BHANUMURTHY: Rupee depreciation is largely an outcome of the developments in the global economy. With the US Fed raising interests aggressively and US dollars flying back to safe havens, there is an outflow of US dollars from India as well. Going by the Reserve Bank of India (RBI) data, there appears to be an outflow of about $60 billion since inflation started firming up in the United States. Add to this the widening of the current account deficit (CAD) following the rising world oil prices as well as some taxes on exports that also appear to have put pressure on the rupee to weaken. In other words, the fall of the rupee could be largely attributed to open-economy macroeconomic issues and less due to domestic macro fundamentals.
ADITI NAYAR: Higher inflation and expectations of sharp monetary tightening by the US Fed have led to a global flight of assets back to the US. This has led the Dollar Index to strengthen over the last several weeks, as a result of which several currencies have weakened sharply. With India being a large commodity importer, fears of a sizeable CAD, large FPI outflows, high domestic inflation readings, and the likelihood of a relatively shallower rate hike cycle by the Monetary Policy Committee (MPC) have contributed to the INR depreciating against the US dollar.
DHARMAKIRTI JOSHI: Two forces—India’s economic vulnerability at the moment, and the magnitude of the external shock—determine the rupee’s volatility. We are less vulnerable—externally—today compared to the taper tantrum period of 2013. Recall that in fiscal 2014, the rupee plunged 11 per cent at the mere hint of monetary policy tightening by the US Federal Reserve (Fed). The current external shock is not only much bigger, but it is also far more complex. For one, foreign funds are scramming on the back of the Fed’s aggressive rate hikes and the greenback’s safe haven currency status in uncertain times. Foreign portfolio investor outflows from India topped $30 billion in the first half of this calendar year, which is the most we have seen in such a timespan. Two, even as slowing global demand is bad news for our exports, high commodity prices due to the Russia-Ukraine conflict, and healthy domestic demand are keeping our import bill high. The CAD is expected to widen to 3 per cent of the GDP this fiscal from 1.2 per cent in the previous. That would require higher capital inflows to fund it. But for reasons just explained, dollars are leaving, rather than arriving at the shores. It is this interplay of rising demand for dollars globally and its reducing supply at home that is roiling the rupee.
AJAY SAHAI: Most advanced economies are not doing well. With the perception that the Fed will increase interest rates, there is a flight of capital, and most currencies are depreciating. Besides the fact that our trade deficit is increasing, that will put more pressure on the rupee.
Q. What does a falling rupee imply for the Indian economy?
N.R. BHANUMURTHY: Although short-term exchange rate movements mostly work as an automatic stabiliser on the external account, a fall in trend value is expected to have differential impacts on different segments of the economy. The conventional view is that a falling rupee props up exports and discourages imports. But it needs empirical verification. Recent trends suggest that within exports, a falling rupee can have a differential impact on goods and services exports, exports earnings in the short term, and real exports in the medium term to long term.
ADITI NAYAR: A weaker INR will bloat the costs of importers and may simultaneously buffer exporters against the higher costs of inputs and wages that are being experienced in some sectors. A falling rupee will also contain the benefit of the recent correction in commodity prices. This may affect government expenditure on some items such as fertiliser subsidy, and also limit the improvement in the domestic inflation readings going ahead. We also remain watchful of services inflation, given the strong demand for services post the pandemic. Overall, we now project FY2023 inflation at 6.5 per cent, lower than the MPC’s forecast of 6.7 per cent.
DHARMAKIRTI JOSHI: The first negative effect is on inflation. Our estimates show ‘imported inflation’ contributes to as high as 60 per cent of WPI inflation, up from an average of 30 per cent in the past five years. The impact on consumer inflation has been less, but as that has already breached the RBI’s tolerance limit of 6 per cent, a falling rupee is an additional headache. Second, it makes servicing of foreign debt costlier. According to the RBI’s latest Financial Stability Report, 44 per cent of India’s external commercial borrowings were unhedged last fiscal. That said, a weak currency supports exports to an extent and helps reduce trade deficit. But that benefit is now waning with global demand slowing.
DR AJAY SAHAI: The falling rupee is a big concern, particularly at a time when we are fighting inflation. Since our imports are more than exports, it will make many sectors less competitive. One has to look into relativity and therefore no thumb rules apply to rupee depreciation impacting exports.
Q. Are you satisfied with India’s currency management?
N.R. BHANUMURTHY: The RBI appears to be actively intervening in the forex market, especially to maintain stability while not targeting the level of the exchange rate. Added to that, some of the recent measures to attract foreign capital should also help in currency management. RBI permitting trade invoices in rupee should cushion the dollar demand to some extent. But most importantly, this time around there is perfect coordination between India’s fiscal and monetary authorities and this augurs well for overall Balance of Payment management.
ADITI NAYAR: The INR has displayed less volatility than many EM (emerging market) currencies. Forex sales by the central bank, a host of timely measures to support the currency, and a period of relatively lower crude oil prices have contained the extent of the INR weakness over the last few weeks. The RBI has recently introduced several measures to support the INR, such as relaxations for NRI deposits, external commercial borrowings and short-term investments in FPI-debt securities, which should modestly boost inflows. Additionally, measures towards international trade settlement in INR should hasten the internationalisation of the INR over the medium term.
DHARMAKIRTI JOSHI: It has been quite pragmatic with an array of tools being used. The experience of past currency crises shows that forex reserves, even if sufficient, can quickly burn in case of a run. Hence, alternative channels are required. The RBI has resorted to intervention in the spot and forward markets as the first line of defence. It has also announced measures on the capital account to woo forex, such as exempting foreign currency deposits from statutory reserve requirements, and easing provisions on remittances. The government, on its part, has hiked import duty on gold to discourage imports (similar to when the taper tantrum occurred) and introduced gold bonds as an alternative to physical gold investment. But high import duty can encourage smuggling and should be transitory.
AJAY SAHAI: We are a market-driven economy. The RBI has a limited role to intervene to manage excess volatility. If it intervenes more, it will increase the money supply, which could be inflationary. RBI’s objective has been to intervene when it breaches a milestone.
Q. How low can the rupee go? Your outlook on rupee and the Indian economy…
N.R. BHANUMURTHY: In the short term, it appears that the rupee could weaken further, especially due to the expected tightening of interest rates in the US. But in the medium to long term, with strong macro fundamentals, the currency may not slip further. Mind you, during the latest crisis, unlike advanced countries and some EMEs (emerging market economies), India adopted growth-oriented and mostly supply-side fiscal policies, and this should help improve productivity vis-à-vis our trading partners.
ADITI NAYAR: With the rebound in crude oil prices and the expectation that the US dollar will remain relatively strong in the immediate term, the INR may depreciate further to 81.0/$ in Q2FY2023. With the spike in US inflation, expectations of aggressive monetary tightening by the US Fed have led to fears of a global recession, which has led to a considerable correction in commodity prices. Our sense is that while rate hikes by the Fed may be large and front-loaded, they may end sooner than expected by the markets if the recent downtrend in global commodity prices sustains and transmits to lower inflation readings. This will pare risk aversion and help EM currencies such as the INR correct to an extent in H2FY2023. In our view, with domestic services demand appearing robust, lower global commodity prices are a positive for India’s economic outlook. The recent correction in key commodity prices, including crude oil, amid fears of a global recession, is likely to ease the pressure on input costs and hence the margins of India Inc. in the immediate term, despite the weaker INR. If this downtrend sustains, we see a tangible upside to our estimate of YoY GDP growth of 6.5-7.0 per cent for Q2FY2023.
DHARMAKIRTI JOSHI: The rupee could continue testing 80+ levels in the near term as global risks keep piling up, the Fed remains hawkish, and India’s external vulnerability is on the rise. The global financial crisis and taper tantrum episodes tell us that, while the rupee overshot its long-term trend at the peak of the shock, it also corrected when the risks subsided. So we do expect it to appreciate to below 80 levels by the last quarter of the fiscal. We see GDP growth at 7.3 per cent for this fiscal, with risks tilted downwards, and inflation at 6.8 per cent. Most economic indicators point to a healthy economic performance in the April-June quarter.
AJAY SAHAI: Global trade is entering a difficult phase. The inventories are pretty high, affecting the demand. The high inflation globally and recession in advanced economies are other challenges, contracting demand. Besides, the commodities prices are declining, affecting exports value. At the current level, we expect exports to be around $ 460-470 billion. If the geopolitical situation improves, these projections may change dramatically.
Q. What can the government and RBI do as INR weakens?
N.R. BHANUMURTHY: Both RBI and the central government have been undertaking various measures to contain the free fall of the rupee and those measures have been largely successful. Now the focus should be more on managing inflation expectations as well as ensuring speedy implementation of projects under the public sector that could crowd in private investments as well as improve the growth potential. In my view, the prudent macro-fiscal policies that India has adopted since the Covid-19 period could help withstand the global headwinds that IMF and other agencies have predicted to prolong even in 2023. Let the rupee find its true value.
ADITI NAYAR: FII equity outflows have eased in July 2022 to $1.1 billion in the first half of the month, after averaging a substantial $4.7 billion in the previous six months. Moreover, FDI inflows stood at $12.7 billion in April-May 2022, an admitted YoY decline, but robust compared to the pattern in earlier years. As long as EM currencies are weakening, some INR depreciation is inevitable, and may be warranted to protect export competitiveness. However, if the INR crosses 80.5/$ in a sustained manner, further RBI and government measures may be forthcoming. The central bank could, for instance, open a special swap window for oil marketing companies to take care of their daily forex requirements, thereby reducing dollar demand in the market; this measure had proven to be effective during the 2013 taper tantrum.
DHARMAKIRTI JOSHI: As long as global developments dictate the rupee’s weakening, there is not much policymakers can do to reverse its direction. They can, at best, continue to act on the lines they already are, to ensure depreciation is orderly during the turmoil. As things stand, the rupee will pose a near-term challenge to policymakers, unless commodity and crude prices correct sharply.
AJAY SAHAI: I don’t think they should intervene—the only thing the government can do is manage excess volatility. We will prefer that the rupee remains at 4-5 per cent of volatility. That is something we can manage.