The Indian rupee fell to a lifetime low in trade as a confluence of factors ranging from a stronger dollar, to higher oil prices, a wider current account deficit and foreign portfolio outflows pushed the currency lower.
The rupee fell to 69.09 in intraday trade compared to yesterday’s close of 68.63. It recovered to close at 68.75 following some intervention from the Reserve Bank of India, said currency traders. The previous all-time intraday low for the rupee is 68.86 against the dollar—a level hit on Nov. 24, 2016. The all-time closing low still stands at 68.82, breached on Aug. 28, 2013.
So far this year, the Indian currency has weakened about 8 percent, making it the worst performer in Asia.
The Current Account Deficit Club
If in 2013, currencies of economies labelled as the ‘fragile five’ were worst hit, then in 2018, the market appears to be punishing current account deficit economies.
Pressure of currency depreciation started with countries like Argentina and Turkey. However, the pressure has filtered through slowly into other economies with widening current account deficits, noted JPMorgan in a note dated June 19.
It is increasingly clear that emerging market current account deficit (EM CAD) economies are being clubbed together as an asset class and therefore at risk of some contagion from each other. Just being an EM CAD country in this environment makes one vulnerable to redemptions and outflows.Sajjid Chinoy & Toshi Jain, JPMorgan
In India’s case, the current account deficit is expected to widen to 2.5 percent of GDP in FY19. While this is below the 3 percent mark, which is typically seen as unsustainable, the combination of a wider current account deficit along with capital outflows could put pressure on India’s balance of payments. Foreign portfolio investors have sold over Rs 46,000 crore in debt and equity so far this year - the most in a decade.
Reserve Bank of India Governor Urjit Patel, in a recent editorial in the Financial Times, warned of dollar funding drying up for emerging market economies. In his view, higher borrowings from the U.S. government against the backdrop of reduced liquidity due to the unwinding of the U.S. Federal Reserve’s balance sheet will mean that emerging markets could face a ‘dollar double whammy’.
A More Measured Depreciation?
To be sure, the depreciation in the Indian rupee, which has taken it to record lows, has been far more measured than in 2013. Back then, India was seen particularly vulnerable due to the high and volatile inflation levels in the economy.
Since then, India has become an inflation targeting economy. In FY19, inflation is seen at close to 5 percent, a far cry from the bouts of 8-10 percent inflation seen in the 2010-2013 period. Real interest rates in India have also been consistently positive over the last two years compared to the negative rates prevailing at the time of the 2013 currency crash.
Other macro indicators are also more stable.
The center’s fiscal deficit is seen at 3.3 percent this year compared to 4.5 percent in 2013-14. The foreign exchange reserve cover, despite some decline in reserves in recent weeks, remains at 10 months of imports.
While noting that the Indian rupee has been one of the worst performing currencies in Asia this year, Fitch Ratings said that the depreciation has been more muted than in the 2013 taper-tantrum episode.
India has better macroeconomic fundamentals than in 2013 and very low foreign ownership rates in the domestic government bond market, but the current account deficit has been widening as a result of rising oil prices, reviving domestic demand and poor manufacturing export performance.Fitch Ratings Global Economic Outlook (June 13)
The Silver Lining
While a weaker rupee will hurt existing portfolio investors, it may help the real economy.
The 36-country trade weighted real effective exchange rate (REER) has fallen to 114.67 in May, shows RBI data. A year ago, this index was at 119.48. A level higher than 100 suggests overvaluation while a level below that suggests undervaluation.
The perceived overvaluation is seen as one reason behind the sluggishness in Indian exports. It also makes imports more viable, thereby worsening the core trade balance, which is measured by stripping out items like oil and gold. This underlying trade balance has worsened by 2 percent of GDP over the last three years, noted Chinoy of JPMorgan in a report in May.
One reason for this could be the near 20 percent real appreciation in the currency during the period of low oil prices.
“Has India therefore been afflicted with the Dutch disease, wherein a large positive terms-of-trade shock drove a sharp real appreciation and impinged on the competitiveness of the rest of the economy?” Chinoy questioned.
The recent fall in the currency could help correct some of the overvaluation of the currency should the RBI not intervene aggressively.
Data of RBI’s forex operations for the month of April shows that the central bank sold a net of $2.48 billion. This included sales of $8 billion and purchases of $5.5 billion, the data, which is released with a lag, shows. The net sales of U.S. dollars are the highest since November 2016, shows data available on Bloomberg. RBI reports sales and purchases of U.S. dollars with a lag, and hence data for the month of May is not yet available.
The rupee’s depreciation over a longer period is also justified given the prevailing inflation differential between India and developed economies. Over the past decade, the rupee has depreciated in all but three years.