Rupee touches slips to 79/$, “ab 80 door nahi”

Rupee touches all-time low

by 5paisa Research Team Last Updated: 2022-06-29T18:05:01+05:30 IST

On 29ths June, the rupee slipped beyond 79/$ for the first time in its history. The RBI had tried to stoutly defend the rupee for some time around the 78/$ levels, but the US dollar appears to be in the midst of a solid bull rally with the dollar index (DXY) consistently above the 104.50 mark. This hardening of the dollar has been triggered by the hawkishness of the US Federal Reserve on the one hand and the pressure on the rupee is heightened by consistent FPI outflows combined with dollar demand from oil companies.

It is in this context that the Indian Rupee weakened from 78.20/$ to 79/$ in a span of just two days. What really stood out was that the RBI did not support the rupee vehemently and it looks like now the rupee may gradually veer towards the 80/$ mark. A big factor has been the FPI outflows in excess of $30 billion since October 2021 with over $6 billion of FPI outflows just in the month of June 2022. This has pushed the oil companies to rush for dollar buying and the surge in demand for dollars by the banks is pressuring the rupee.

The Indian rupee has now depreciated by over 1.5% in the last one week and that is a lot of weakness that is visible in the local currency. Let us look at some key reasons for the free fall in the Indian rupee in the rupee past.

    • One big reason has been the Fed tightening. Higher rates in the US means that more money chases safe havens and goes risk-off on emerging markets like India. This favours the dollar against the Indian currency.

    • The surge in commodity inflation has been a big factor. In the last few months, the prices of crude, metals, minerals and coal have all gone through the roof. In addition, lower forward premiums are also putting pressure on the rupee.

    • What is the connection between forward premiums and rupee value. The 1-year onshore forward premium narrowed to 220 paisa, the lowest level since late 2011. This is making the rupee a less preferred currency for investors as they prefer other EMs.

    • Of course, the dollar strength has been much talked about. The dollar index or DXY is at a 20 year high level on the back of extreme hawkishness shown by the US Federal Reserve. This is a global phenomenon because even the Euro and the Yen have sharply weakened against the US dollar.

    • One reason for the weak rupee is also that the current account deficit is expected to widen in the June quarter and beyond as the trade deficit widens and the services surplus narrows. The CAD improved in March quarter but the real challenge to the rupee value and the sovereign ratings would be in the coming quarters.

    • Like in the case of equities, even currencies have fundamentals, and that is called the Real Effective Exchange Rate (REER). Based on REER, the rupee is still overvalued by around 2%, so a level of around 80/$ would be a reasonable level where the rupee should ideally stabilize.
 

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Will the RBI intervene strongly?


It can be a double edged sword for the RBI. In the last few months, the RBI saw currency reserves depleting by more than $50 billion due to the dollar selling intervention. With the forex reserves at just about 9 months import cover, there is not much room for more risk. Also, for the RBI, weak rupee is good if it restores equilibrium as otherwise it would be detrimental to the growth of exports, which has been one of the driving forces of the India growth story in the last few months. RBI may not want to negatively impact export growth.

With pressure on flows, current account and dollar strength, the best option in front of the RBI is to allow the rupee to adjust to the new reality but in a more orderly fashion. Whether that level is 80 or otherwise, will emerge gradually, but the RBI will ensure it is orderly. Let us also remember that the rate hikes by the RBI, in sync with the rate increases by the US Federal Reserve, will maintain the US-India interest rate differential and protect the Indian rupee from a sharp weakening. That should be good enough.

 

 


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