Explained: Why the rupee is falling and where is it headed in coming months

by 5paisa Research Team Last Updated: Dec 13, 2022 - 05:23 pm 49.3k Views

Since the end of May, the Indian rupee has gone down from Rs 72.39 levels to Rs 75.35 to the US dollar. In fact, the rupee has been among the worst performers among all the emerging market currencies in the last six months. 

Since December last year, the Indian rupee has depreciated 3.3% vis-a-vis the US dollar, and several analysts believe that a further slide in the currency may be in the offing. 

But why is the Indian rupee falling?

One reason is that foreign investors are reportedly positioning themselves for a flight of capital from India, as the US Federal Reserve lays down plans to taper bond purchases. 

Second, rising global oil prices. Every time global oil prices go up, the Indian rupee begins sliding. And the same story seems to be playing out again. Brent crude prices have topped the $83 to a barrel mark, which, along with natural gas prices, could only go up as the world faces an acute coal supply crisis. 

India is a net importer of fossil fuels and depends on 70% of its energy needs for imported oil and gas. Now, with a domestic coal shortage, the country will have to import costly coal from countries like Indonesia, at three times the normal price. This will further impact the rupee, as the country will have to spend US dollars for these imports. 

This higher import cost results in a higher current account deficit, which effectively weakens the domestic currency. 

“High global crude oil prices, supply chain disruption and higher dollar index are responsible for recent rupee slide against the dollar,” Bhaskar Panda, executive vice president at HDFC Bank, said in a report by The Economic Times.

Is the falling rupee necessarily a bad thing for everyone?

Not really. While it does make imports costlier, it makes exports more competitive, as a foreign importer has to pay less in dollar-denominated costs for imports from India. 

So, a weakening of the rupee is not necessity such a bad thing, even if the optics don’t look very good. 

Software services companies, for instance, would be among the main gainers if the rupee weakens since a majority of their revenue comes from outside India.

Could the Reserve Bank of India (RBI) step in to arrest this slide?

The RBI is unlikely to step in just yet, if a report by The Economic Times newspaper is to be believed.

The RBI could keep a hands-off approach in the interest of keeping exports competitive, as the Indian economy begins to emerge out of the ravages of the Covid-induced lockdowns that brought it to a halt and flung it into a recession for the first time in four decades in 2020. 

Also, what gives the RBI some comfort is the fact it is sitting on nearly $640 billion in forex reserves. This would allow it to intervene if there is a sudden flight of capital. 

“The problem of plenty is nothing new for the central bank. The local unit is likely to depreciate but overseas inflows will likely arrest any sudden drop in the rupee's value negating any desperate need of currency market intervention,” said Madan Sabnavis, economist at CARE Ratings.

So, where is the rupee headed from here?

The local currency could depreciate even further, at least in the medium term. “The rupee will likely lose value in the middle term as it is still overvalued compared to other Asian peers,” according to HDFC Bank’s Panda.

IFA Global, a currency advisory firm, says the Rupee is relatively overvalued and volatility was close to multi-year lows until a few weeks ago. “The RBI, therefore, seems to be content seeing the overvaluation get corrected and has not intervened too aggressively by selling dollars.”

Also, the Real Effective Exchange Rate of the rupee has appreciated 1.3% compared with a basket of 40 currencies till September, data from the RBI shows. In the six-currency REER basket, it is up 1.5%. The REER is the weighted average of a currency in relation to an index of major currencies. An increase indicates exports are getting expensive and vice versa.

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