The Rupee fell to a new 5-year low against the US dollar on July 2 at shedding as much as 17 paise vs US dollar to a new 5-year low of 68.9662 before recovering.
So whats causing this and where could we be headed?
5 Reasons Rupee Is Weak
- Foreign Institutional investors have sold assets worth Rs 46,197 crore in the debt and equity market in this year so far. FIIs, meanwhile, were supporting the rupee in the last three years prior to 2018. This weakning in emerging currencies as well as equities (several emerging currencies are down between 5%-10% in the current year so far) is part of a global issue as EPFR confirms in its latest report – risk aversion has been increasing since late last year and outflows from emerging markets have been continuous. In addition, a lot of domestic reasons including impending elections and high valuations have kept FIIs at bay from both debt and equity markets.
- Some experts are of the view that rupee is still overvalued according to the 36-country Real Effective Exchange Rate, which the RBI monitors for currency management. RBI data demonstrates the rupee is overvalued by 14.67 per cent as of May 2018.
- Crude oil prices seemed to gathered steam again following the disruption of output from Libya. Oil prices climbed immediately although an overall rise in OPEC output and an emerging slowdown in demand held back markets. At the time of writing this blog, oil was again boiling.
- Market participants have been closely eyeing the United States’ decision due on 6 July in which the Trump administration is likely to impose tariffs on $34 billion worth of Chinese goods. According to an Associated Press report, the US will start imposing a 25% tariff on $34 billion in Chinese imports this Friday following which China is expected to strike back with tariffs on a like amount of US exports. The Trump administration is also identifying an additional $200 billion in Chinese goods for 10% tariffs, which could take effect if Beijing retaliates.
- The US Federal Reserve has hiked its benchmark lending rates by 25 basis points and has signalled for two more hikes this year. This global tightening means risk averse assets will seek higher yields in relatively safer currencies till volatility subsides and new equilibria are set across the globe and risk taking returns.
What happens Next
Moody’s Investors Services is confident about India and puts it in the 5 countries which are least vulnerable to currency pressures amid strengthening of the US dollar, because of low dependence on external capital inflows. India’s significant build-up of foreign exchange reserves in recent years to all-time highs provides a support buffer to help mitigate external vulnerability risk,” said the US-based rating agency.
CAD, which is the difference between the inflow and outflow of foreign exchange, jumped to $48.7 billion, or 1.9 percent of GDP, in 2017-18 fiscal. This was higher than $14.4 billion, or 0.6 percent, CAD in 2016-17 fiscal.
Experts suggest that the recent volatility is largely not a reflection of India’s macro fundamentals, like it was in 2013. The fiscal deficit was at 4.80 per cent in 2013 compared with 3.50 per cent now. With 11-month import cover, India is in better shape than five years ago when importers could have covered only about six months of payments. India’s foreign exchange reserves in the week to June 15 stood at $410.07 billion.
Despite the rupee underperforming its Asian peers in 2018, this may turn out to be favourable for India’s Make in India initiative by boosting exports and cause a reversal at some stage. Indian exports were valued at $28.86 billion in May compared with $24.01 billion in the year earlier, up 20 per cent.
In this 12-month gap, the rupee lost 4.5 per cent to the dollar.
In the recent weeks, the most bearish forecast for the Rupee has been pegged at Rs 72 while exporters have started booking one year forward contracts at 71.50 a dollar (including premium), suggesting that they are seeking to gain from the rupee’s fall. Importers are rushing to buy these.
From current hehaviour as well as recent efforts by oil buyers it does look like crude may soon be near its highs in which case the incremental depreciation may be limited to somewhere around this range. Between 67.50 (which is the current Bloomberg consensus for year end) and 72 is possibly where we might find the rupee for the rest of the year unless we have a real shock domestically – most likely election related – or via crude prices.