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The fall of the Indian rupee: Is all well?

  Most Indians have watched the plunge of the rupee to nearly `70 to a dollar with growing concern. Several factors have contributed to this fall, including rising prices of crude oil and the global trade war sparked by the US. An analysis of what led to the rupee's fall, and what we can expect in the near future.  

Dr Suresh Srinivasan

During 2018, the Indian rupee has continued to weaken steadily. From the beginning of this year, the rupee has lost almost 7%, and is now inching closer to `70 to a US dollar. In fact, for the first time in history, the rupee has actually breached the `69 to a US dollar mark! Things could have been worse, the rupee may have broken through the `70 mark as well, but interventions by the Reserve Bank of India (RBI) have managed to arrest the freefalling rupee.
Although there is a multitude of reasons for such a weakening, a couple of factors that drag the rupee down are extremely obvious—the increasing price of crude oil, and the fear of escalation in the global trade war.

Factor 1: The crude truth
The steadily increasing price of global crude oil is a major factor that contributes to the weakening of the Indian rupee. From the beginning of the year, international crude oil prices have largely risen. The international price of Brent crude oil has increased by around 20% during this year alone, and has crossed $80 to a barrel. It is to be noted that this is the highest the price has reached in the last four years.
Geopolitics is the main reason for such an increase in crude price. The Donald Trump-led United States administration recently pulled out of the Joint Comprehensive Plan of Action (JCPOA), more commonly known as the Iran Nuclear Deal, which was signed between Iran and the United Nations Security Council comprising China, France, Russia, the United Kingdom, United States and Germany in 2015. The US’s controversial action of pulling out of the agreement and warning Iran that the strongest ever sanctions were likely to follow triggered off a series of uncertainties, resulting in the eventual increase in the price of crude oil.

India’s import of crude
India imports large volumes of crude from Tehran; it is the largest supplier to India after Saudi Arabia and Iraq. India imports close to 0.8 million barrels a day from Iran. Tehran is considered to be a trusted trade partner of India, and offers favourable terms for its supply of crude oil to India. India may have to suspend this favourable track of imports from Iran.
Clubbed with the fact that the US is calling for more severe sanctions on Iran, and India is importing close to 80% of its crude oil requirements, analysts claim that the increasing crude oil price is one of the major risk elements that confronts the Indian economy today. The risk perception is high and hence, there is a fear that the rupee will depreciate even further in the future as well.
A depreciating rupee along with higher oil prices is a major dampener for the Indian economy. Over the last four years, the current NDA government has been lucky as the oil price has remained quite low. This has greatly helped the government in keeping the budgetary deficits low. However, as we creep closer to the election year of 2019 and with the oil price inching upward, the economic health of the country looks to be in for a shake up. In 2018 alone, retail prices of petrol in the pumps have increased close to 10% and diesel by around 15%. This is an extremely sensitive issue when it comes to the sentiments of the voting public, especially in the election year.

With crude price ever increasing and fuel price rising at the pumps, inflation is steadily growing. Retail inflation reached its highest levels in the last five months. For the last eight months, inflation had remained higher than the RBI’s medium-term target of 4%.
The Reserve Bank of India (RBI) increased interest rates for the first time in the last four years to battle inflation.  Although inflation has not been a major issue up until this point in time, it is seen as a problem in the near term future, as crude prices remain high, with an outlook to increase further. The depreciation of the rupee is expected to increase the import bill of crude oil, thereby exerting pressure on the fiscal deficits, which as all of us know is already under enormous strain.

Factor 2: Trade war
The second major reason for the weakness in the Indian currency is the brewing global trade war. Trade war not only infuses negative sentiments in economies, but also has another dimension to it—triggering off a global currency war. With global oil prices increasing, most of the Asian economies, which are net oil importers, will demonstrate a trend of weakening currencies. If India does not depreciate its currency and forcefully hold it up, as it did recently through the RBI’s intervention, then the Indian exports could become uncompetitive in the global markets.
In essence, it would be a healthy trend for India to allow its currency to depreciate in line with the rest of the regional currencies, in order to remain export competitive.

Factor 3: Investment cooldown
The third reason why the rupee is seeing such depreciation is due to the fact that foreign investors are pulling funds out of emerging markets, including India. The foreign portfolio investors have pulled out close to US$2 billion from the Indian markets. India’s foreign currency reserves are also steadily falling, and have now been depleted by more than $5 billion within a short span of two weeks. The total reserves are now inching closer to breach the $400 billion mark. If the RBI attempts to arrest a further fall in the value of the Indian rupee and decides to intervene, the reserves would plunge further to breach the $400 billion mark.
Traditionally, the impact on exports is considered to be positive when the currency depreciates. However, this may not hold true in the current scenario. This is mainly because it is not only our currency that is depreciating. Since all Asian economies are facing the same issue, India will not really gain any undue advantage. Going forward, it is expected that the rupee could depreciate further, and will most likely breach the `70 to a US dollar mark, and be range bound between `69 and `72 to a US dollar.
India’s dollar denominated oil imports will now increase, thereby exerting pressure on the Indian rupee. This will lead to inflation and consequently increased interest rates, which in effect means that the liquidity of funds in the market will reduce, thereby reducing the growth rate of the economy. At a time when the government is going all out to demonstrate higher growth, such a scenario will be a surefire dampener. More importantly, populist spending will expand the deficit, which is something the government is seriously attempting to consolidate and curtail. So from a pragmatic point of view: Can the government come up with alternatives to fix the problem at the earliest? Not really. And that is certainly not good news for the current government that is aspiring to run for a second term.

On balance, two main issues will drive the strength of the Indian rupee. How the crude oil price moves over the short to medium term, and the extent to which our Asia Pacific neighbours depreciate their currencies. India needs to ensure that its currency depreciates almost in line with the regional currencies in order to ensure the competitiveness of its exports. This could, however, be further aggravated by the trade war, if it gets escalated, which can exert further pressure on the currency of countries in the region. Overall, the weak outlook of the Indian rupee, prevailing weak economic conditions and election year approaching, in totality, spell negative sentiments. It is not difficult to realise that the outlook is going to be complex and uncertain.