Rupee has seen its biggest single day fall in last 5 years and it has hit 70 against the US Dollar (USD) for the first time. This has led to a furore and pandemonium. One end of the political spectrum is portraying it as the failure of the ruling dispensation and as expected, the Govt. of the day is saying that the fall is nothing worrisome and is due to the external factors. Infact Subhash Chandra Garg, Secretary, Department of Economic Affairs, GoI has gone to the extent of saying “Even if the rupee falls to 80, it will not be a concern provided all other currencies also depreciate.”
Rupee or for that matter any currency falls against the US Dollar whenever outflow of US$ is more than the inflow of US$, therefore to understand this fall in INR, let us see what has prompted higher US$ outflow this time.
1. The Turkish Lira Contagion – Whenever there is economic uncertainty, big money rushes towards the safer currencies. The Turkish embroglio has impacted all emerging markets and investors are moving their money from India/Turkey/other EMs to US$ based assets. This has increased the outflow of US$ thereby increasing the price of US$.
2. Higher Crude Oil Prices – Higher Crude Oil prices mean demand for more US$ as the Oil Imports are US$ denominated. Just as an example, The crude Oil Import Bill of India for May’2018 is $115 billion as compared to $76 billion in May’ 2017 that’s a whooping 51% jump, which is in line with the year on year jump in Brent prices. Even if the crude oil price tapers a bit, India will continue to pay more because of the fall in INR.
3. Non-Oil Non-Gold Trade Deficit – This simply means that even if we exclude Crude Oil & Gold, India is importing more than its exporting. This non-oil, non-gold merchandise deficit is consistently widening. The deficit widened to $53 billion in the year ended 31 March 2018 compared with $17 billion in the year ended 31 March 2015. To finance more imports we need more US$.
4. Outflow of Foreign Capital – As per the of National Securities Depository Limited (NSDL), Foreign investors have taken out Rs 35,356 Crore since 1 January 2018. Whereas their net addition was Rs. 43,127 Crore in year 2016 & 2017.
Now let us see how the Rupee Depreciation affects the economy & us:
1. Higher Inflation – The Crude Oil & other imports will become expensive, this will mean that the general price level will increase as the fuel cost and the cost of other material will increase. The Reserve Bank of India estimated in its monetary policy report in April that for every 5% fall in rupee, retail inflation will increase by 0.2%.
2. Higher Interest Rates – To combat the resultant inflation RBI will have to raise interest rates so that less money flows in the system. Because if a lot of money chases things, the prices increase further. Higher interest increases the cost of loans, this affects individuals as their Home/Car Loan EMIs go up and industries also get impacted.
3. Slow Growth of Economic Activity – Higher interest rates control inflation but they restrict the money supply in the economy, thereby impacting the circulation of money which means brakes on the economic growth.
4. Widening of the current account deficit – The gap between foreign earnings against expenses have the potential of increasing CAD. Normally, foreign capital inflows help in bridging the gap and easing the overall balance of payments, which includes both the capital account and current account balances. But given the global risk aversion, those prospects are dim. As per a Nomura Securities report, every $10 rise in the crude oil price widens India’s fiscal deficit by 0.1% of the GDP.
5. Impact on Corporate Profits – A declining rupee adds to the pressure on corporate profit through higher input/fuel costs. Their Loan costs increase too. Companies with foreign currency loans are doubly affected.
6. Impact on Foreign Investment – As the currency value goes down more and investors pull out and more and more investors pull out the currency depreciates more.
7. Gain to Exporters – The only happy party in the case of a depreciating INR is an exporter. A falling rupee helps exporters as they get more local currency per US$ but the impact is partially offset by the rising input costs. As per the studies, a 1% change in the rupee-dollar exchange rate has a 0.40% impact on margins on average.
What can RBI do to stem the INR Fall – RBI has substantial Forex Reserves (US$ 406.1 Billion as on 29-06-2018) they fully meet the IMF norms for reserve adequacy and there is no cause for undue concern.
Image Courtesy – IMF Website
With that large war chest, RBI can intervene in the currency market if the Rupee Depreciation continues. However, this seems to be an over reaction to the Turkish Lira situation and the situation is expected to improve soon. Though, to present both the points of views Peter Brandt, a well known Finance Professional has given a statement that if INR breaks the level of 71, it may fall upto 80. Will it play out or not only the time will tell.