Image of rupee notes used for representational purposes. (PTI)

Rupee Breaches 72 Against U.S. Dollar For First Time

The Indian rupee crossed the 72-mark against the U.S. dollar for the first time, as weakness across emerging market currencies, rising oil prices and limited intervention from the RBI dragged the unit down further. The falling rupee, in turn, has pushed bond yields up with investors fearing the fallout of weaker currency on inflation in the economy.

The rupee dropped as much as 0.5 percent to 72.1050 intraday against the dollar before closing at a new record low of 71.99.

Rupee Breaches 72 Against U.S. Dollar For First Time

A “deteriorating emerging market risk backdrop” and pressure on current account deficit currencies has led to the rupee hitting record lows, said Nomura Global Markets in a research note on Wednesday. The brokerage sees risk of further depreciation for the Indian rupee due to a mix of domestic and international factors.

Local factors for depreciation include limited intervention by the Reserve Bank of India and limited concerns, in our view, over forex depreciation (watch this space), a lack of urgency to hike rates, rising political risks, and a large trade deficit with a higher oil price and portfolio outflows.  
Nomura Global Markets

The rupee has now fallen nearly 11.5 percent so far this year and continues to be the worst performer in Asia.

The currency has rarely seen an over 10 percent depreciation in such a short span. Other periods when the rupee has weakened this sharply include the time of the global financial crisis and the taper tantrum. To be sure, conditions in the market appear relatively more orderly now than they did in 2013 and in 2008.

Inflation Fears Rise

While some believe the Indian rupee was due for a correction, the pace of depreciation has led to fears of a rate hike.

On Wednesday, the fall in the rupee led to incremental selling in the bond markets and pushed up the benchmark 10-year yield to 8.10 percent intraday. The 10-year yield was trading at 8.06 percent at 1pm on Thursday. Bond prices and yield are inversely correlated.

According to an estimate provided by the RBI in its April Monetary Policy Report, a 5 percent depreciation of the Indian rupee could lead to a 20-basis-point increase in inflation. This could prompt the Monetary Policy Committee to raise rates a third time this year.

If pressure on emerging markets—and therefore on the rupee and forex reserves—sustains through September, “the calculus” of the October MPC meeting is likely to change, Sajjid Chinoy, chief India economist at JPMorgan, wrote in a report on Monday.

The MPC will need to be forward-looking and assess the impact of the weakening currency and oil prices (with crude now above $77) on future inflation. More fundamentally, the value of monetary policy being both preemptive and orthodox—and the deleterious consequences of not being so – has been on display across emerging markets in recent months.  
Sajjid Chinoy, Chief India Economist, JPMorgan

The lack of intervention by the RBI in the currency market is the single point of pain pressure plaguing the market at this point in time, said Lakshmi Iyer, chief investment officer at Kotak Mahindra Asset Management Ltd. "But a knee-jerk reaction may not be warranted immediately since we have the monetary policy decision slated for next month," Iyer told BloombergQuint in an interview.

Costs And Benefits Of A Weaker Rupee

Government officials have argued that a weaker rupee will benefit the economy by pushing up exports and bringing down non-essential imports. That commentary has, in fact, led to some additional weakness in the currency and traders saw it as a signal that the government and the RBI would not intervene to stem the fall in the rupee.

However, policymakers should be equally mindful of the costs of rupee depreciation, said Soumya Kanti Ghosh, chief economist at State Bank of India in a report on Thursday.

Ghosh highlighted a number of costs of the weaker rupee including:

  • Oil import bill could go up manifold
  • High cost of rollover of short term debt obligations of corporates
  • Fiscal costs of higher bond yields
  • Higher inflation due to increased cost of imports

This could be, thus, the biggest predicament waiting to unravel, wrote Ghosh.