What is the reason for sustained fall of rupee and how does it impact CAD?

What is the reason for the sustained fall of the rupee?

The rupee is not alone even as it approaches 74 against the dollar. The fall in emerging market currencies is led by the Turkish lira, Argentinian peso, Brazil’s real, South African rand and Russian ruble as a risk-off environment has set in after the US imposed tariffs on Chinese goods. China, in retaliation, let its currency depreciate to adjust for the loss. Countries that export goods to the US have subsequently let their currencies depreciate to preserve their own competitiveness. At the same time, the US interest rates are rising, making that market attractive for investors who generally chase high yields in emerging markets. India is a major beneficiary of this flow, which is now reversing. The spike in oil prices to $86 a barrel now, from less than $50 a year ago, is a matter of great concern for countries like India, which imports 70 per cent of its oil needs. The reason the rupee’s fall of 12 per cent this calendar year looks sharper is that the currency had remained stable, or even strengthened against other currencies, since 2013. 

How does a weak rupee impact the current account deficit?

A current account deficit (CAD) arises when a country imports more than it exports. India runs a CAD of 2-2.5 per cent of the gross domestic product, which rises and falls depending to a large extent on the prices of crude oil. Theoretically, if CAD widens, that means the country needs more foreign exchange, say dollars, to finance its bills. This demand for dollar then pushes up the cost of dollar, representing a depreciation of the rupee against the dollar. So, the wider the CAD, the weaker the rupee should be. Now, India depends on foreign portfolio inflow to finance its CAD to a large extent. At a time when foreigners are taking out money, there is even more pressure on the rupee and it depreciates faster as a result.

Should the Reserve Bank of India (RBI) intervene?

Opinion is divided on this. That the rupee needed to fall, everyone agreed. However, the rupee might have fallen too much, and too fast — that is what a majority of the currency dealers and economists are saying. There are others who say the rupee should find its own level without intervention as the currency has remained quite strong for a couple of years. At its worst during the 2013 taper tantrum crisis, the rupee was at 68.87 to a dollar in August that year. From there, the rupee at 74 might not look too bad after all. However, from its January 2018 level of 63 a dollar, the rupee’s fall seems sharp. 

The RBI maintained a hands-off approach for a long time, holding on to its foreign exchange reserves at $400 billion. However, the central bank did intervene in August and September, to the extent of $26 billion in spot, and another at least $10 billion in the forwards. Still, the rupee is sliding and might continue to do so unless global crude prices show signs of easing. But any uneven volatility could be ironed out, which is also the official stance of the central bank. 

Who loses and who gains from the rupee slide?

The answer is not very simple for India. First the theory: It states that exporters (who earn in dollars) stand to gain as they earn more rupee for their dollars. Similarly, importers lose as they now have to spend more in rupee terms. In the case of India, though, except perhaps software companies, most exporters are also importers of raw materials. For example, India is known for its gems and jewellery exports — but it generally exports finished goods. The raw material — diamonds and gold in this case — have to be imported first. 

What have the government and the RBI done so far? What next?

For a long time, the RBI and the government did not do much. However, upon the rupee approaching 73 for a dollar, the government came up with five measures to improve dollar inflow. But those measures wouldn’t have yielded immediate relief and the rupee depreciated even more. Now, the RBI has allowed oil marketing companies to raise up to $10 billion from the foreign market, but that is clearly not enough. There can be a couple of more measures, such as dollar bonds for non-resident Indians, or even direct dollar swap window for oil companies. To cut the speculators in the market, the RBI can also go for a big-bang intervention so that positions are cut and margin calls are triggered. But those measures are usually not taken by the RBI.