Rupee reality can be best understood from a global context
A sharp depreciation in currencies of crisis-laden countries like Argentina, Turkey and also Venezuela (which recently replaced its currency and pegged it to crypto-currency petro) has further accentuated the risk. However, it should be noted that India has seen relatively lower foreign equity outflows CYTD in 2018 compared with other emerging markets in Asia due to India’s lower dependence on external trade (as a percentage of GDP), compared with most other emerging markets.
The rupee has fared better than other fragile emerging market currencies this year, and stands better placed than during the Fed Taper Tantrum of 2013. Even though the rupee has depreciated rapidly in the past couple of months and hit life-time lows, year to date in 2018 it has fared better than a host of other fragile emerging market currencies such as the Argentine peso, Turkish lira, Brazilian real, Russian ruble and South African rand. (see performance table)
The relative better performance of the Indian rupee has been supported mainly by continued strong fundamentals. India’s GDP growth is now recovering, and the country is projected to be one the fastest growing major economies this year.
The banking sector, which had been plagued by huge NPAs is bottoming out and our foreign exchange reserves also remain at healthy levels.
The rupee is better placed now, and we may not require any extreme measure by the central bank, if we compare the current rupee situation with that in 2013. In 2013, the rupee was one of the poor performing currencies, and had fallen by 17-18 per cent between April 2013 and August 2013. There were various macro issues, such as elevated twin deficits (current account deficit and fiscal deficit at nearly 4.8 per cent of GDP), Brent crude price was at an average of $110 a barrel, consumer headline inflation was at an average of 9.8 per cent, and GDP growth was at a modest 5.5 per cent.
All these macro-economic variables have improved considerably over the years —with current account deficit (CAD) and fiscal deficit improving to 1.9 per cent and 3.5 per cent of GDP, respectively, in FY18. Brent crude price was at an average price of $58 in FY18 (although presently over $80 mark), consumer headline inflation at an average 3.5 per cent and GDP growth was at 6.7 per cent (expected to rise to 7.4 per cent in FY19).
Even our import cover presently stands at around 10 months, compared with a low of six months in mid-2013.
Factors putting pressure on the rupee
Typically, currencies of countries with CAD, are more susceptible to currency depreciation. It can be seen that countries with relatively higher CAD (like Turkey, Argentina, South Africa, India, Indonesia, Brazil, Australia) have seen their currencies depreciating considerably this year, and also during the taper tantrum of 2013.
Moreover, countries that are undergoing economic and political crisis like Argentina, Turkey and Brazil have witnessed a much sharper depreciation. Russia on the other hand, has seen its currency depreciating this year, primarily due to sanctions by the US, and also due to subdued economic growth.
Another interesting point is that Thailand has turned from a current account deficit country earlier (CAD of 1.2 per cent of GDP in 2013) to a current account surplus of almost 11 per cent in 2017. This has benefited the Thai Baht, which has been one of the top performing currencies year to date in 2018 and also over the past few years, compared with a substantial depreciation seen during the Fed Taper Tantrum of 2013 (when it ran a deficit).
Typically, it is the capital account (including foreign inflows) that funds current account deficit. Otherwise, there will be a balance of payments deficit. In India, the CAD has reduced from a high of 4.8 per cent in FY13, to 0.7 per cent in FY17, and increased to a modest 1.9 per cent in FY18. However, rising crude oil prices has primarily caused the CAD to widen to 2.4 per cent of GDP in Q1FY19 from 1.9 per cent in previous quarter. Balance of payments turned into a seven-year high deficit of $11.3 billion during the quarter, due to widening CAD and a sharp slowdown in capital flows.
India is a large net oil importer, and oil imports account for around 80 per cent of domestic oil demand. Moreover, the share of electronic goods imports has increased considerably over the past few years, which is also putting pressure on the trade deficit.
If FII flows continue to be weak, balance of payments (BOP) may turn meaningfully negative in FY19, compared with a surplus of $43.6 billion in FY18. Estimates, put CAD for India at 2.7-3 per cent of GDP in FY19, which is putting pressure on the rupee.
The escalating trade war between the US and China is also putting pressure on currencies, and it has raised concerns of disruption in world trade (possibly leading to currency wars), and the possibility of China devaluing its currency, to counter the tariffs—if it spirals out of control.
Also, the unwinding of US Fed Balance sheet, along with hiking of interest rates by the Fed, will generally lead to gradual withdrawal of dollar liquidity, which is causing the strength in the US dollar.
Various steps to stem the fall in the rupee
The government has recently announced some measures to stem the fall in the rupee. These include various measures to boost capital inflows such as:
• Allowing manufacturing companies to access ECBs up to $50 million with a minimum maturity of 1 year (vs 3 years earlier).
• Removal of exposure limit of 20 per cent of FPIs corporate bond portfolio to a single corporate group.
• Exempting Masala bonds issued this financial year from withholding tax, and removing restrictions on Indian banks' market making in Masala bonds.
The government also recently announced customs duty hike on non-essential imports to help and curb the widening trade deficit. The government has currently focused on hiking duty on consumption goods mainly (like consumer durables, gems & jewellery etc.) while avoiding capital goods.
In value terms, these items would be around Rs 86,000 crore in FY18 (nearly 3 per cent of total imports). While the impact will be minimal, the move should be seen as government’s intention to address the issue. There could be more announcements later, if the situation aggravates.
Besides that, it has reiterated commitment of sticking to its fiscal deficit target of 3.3 per cent for FY19, although the deteriorating macros will put some pressure on that, and make it a challenge. Various media reports have indicated that the government could also resort to raising foreign money through the route of NRI deposits, the way it had done during the taper tantrum of 2013, to stem the fall in the rupee.
Besides this, RBI has also been intervening in the forex market by selling dollars to help support the rupee, and data shows that RBI has intervened to the extent of $26 billion in the spot and forward market between April – July 2018, thereby also causing some dip in our forex reserves from a high of $425 billion to around $400 billion currently.
However, indications are that since then, the pace of RBI intervention has slowed down. After all there is not much the RBI can do, if there is a global risk aversion in EM currencies.
The above mentioned measures should help to stem the fall in the rupee to some extent; although the rupee can see some further pressure in the short term if oil prices rise further, global risk aversion in EM currencies continue, or trade wars escalate.
Having said that, much of the pain in the rupee already seems to have been factored in. Also, besides the stop-gap measures to support the rupee, the government needs to focus on structural issues—which is the fall in India’s exports.
RBI data shows exports as a percentage of GDP has fallen by more than 5 per cent over the past four fiscal years ended FY18. Long-term structural measures are needed to help boost and aid exports, as it is unlikely that a weaker rupee by itself will cover the gap to the full extent.