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Friday, Oct 07, 2022

Rupee falls below 80 against dollar, raises worries over imported inflation

Although the rupee has depreciated against the US dollar, it has appreciated against other major currencies such as euro and the Japanese yen.

On Tuesday, the rupee traded neutral to range-bound between 79.85-80.05 and closed at 79.95 as the dollar index stayed in muted trading sessions. (Illustration: CR Sasikumar)

Raising concerns over high imported inflation, the rupee Tuesday fell below the psychological level of 80 to 80.05 against the US dollar intra-day amid tightening monetary conditions and risk-off sentiments as well as persistent outflows from domestic markets.

Significant dollar demand from oil importers amid elevated crude oil prices and concerns about swelling trade deficit have also been key catalysts behind the steep descent seen in the Indian currency, which has fallen by over seven per cent since January this year.

Although the rupee has depreciated against the US dollar, it has appreciated against other major currencies such as euro and the Japanese yen. “Global factors such as the Russia-Ukraine conflict, soaring crude oil prices and tightening of global financial conditions are the major reasons for the weakening of the Indian rupee against the US dollar,” Union Finance Minister Nirmala Sitharaman said in a written reply to Parliament.

Currencies such as the British pound, the Japanese yen and the euro have weakened more than the Indian rupee against the US dollar and, therefore, the Indian rupee has strengthened against these currencies in 2022, she said.

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In a Twitter post last week, Sanjeev Sanyal, Member, Economic Advisory Council to the Prime Minister, had said, “The RBI is using reserves to smoothen move but correctly allowing market adjustment… the only real cause for concern is imported inflation from energy prices. Given oil import dependence, there is little India can do about this in short term beyond some domestic adjustments (say cutting taxes at the margin) but all such measures have a price.”

Even as commodity prices have eased from their peak, they are expected to pose a substantial risk for inflation as almost three-fourths of India’s inflationary pressure is seen emerging from imported inflation. Capital outflows and the RBI’s defensive action to protect rupee from a sharp slide against the dollar have resulted in lower forex reserves, posing concerns for the country’s current account deficit in this fiscal.

On Tuesday, the rupee traded neutral to range-bound between 79.85-80.05 and closed at 79.95 as the dollar index stayed in muted trading sessions.

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“Further, the capital market showed positive performance which helped the rupee stay in a range-bound session. In opening trade, the rupee touched a fresh low of 80.05 but took support there after an inch higher towards 79.85. The rupee range can be seen between 79.70-80.25 going ahead,” Jateen Trivedi, VP Research Analyst at LKP Securities, said.

“We do see some more pain for the domestic currency in the near term, but it is likely to remain cushioned by the 81-mark amid a host of factors. For one, the strength in the dollar index seems unsustainable at higher levels, with expectations that the European Central Bank and other developed market central banks will also hike interest rates aggressively,” said Sugandha Sachdeva, Vice President, Religare Broking Ltd. The rupee has depreciated by around 25 per cent since December 31, 2014.

Explained

Inflation risks remain

Commodity prices have eased from their peak, but are expected to pose significant risk for inflation since almost three-fourths of inflationary pressure is seen emerging from imported inflation.

According to analysts, long-term inflation expectations have fallen in the US, and concerns of super-sized tightening by the US Fed at the forthcoming meeting have eased, which is leading to a retreat in the dollar index from multi-year highs and aiding the local unit. Besides, the US central bank might be forced to pause its rate hike cycle going forward given the concerns about recessionary risks and it seems that the worst is likely to be over soon.

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“Secondly, the RBI and the government have recently taken several measures which might stem the fall in the rupee. The rupee-dollar exchange rate is expected to hover in the 78.50 to 81 band till September,” Sachdeva said.

Foreign portfolio investors (FPIs) have pulled out Rs 2.37 lakh crore since January this year and forex reserves have dwindled by $62 billion from the September 2021 peak of $ 642.4 billion.

Although commodity prices have come down from their recent peaks, they are still elevated for a larger trade deficit or current account deficit, which is expected to be 3 per cent.

“That is putting pressure on currency. The capital flight which is taking place, this year we are likely to have a deficit on the balance of payments. So basically, our capital account inflows are likely to be lower than the current account deficit. And if we look at our forex reserves, which are predominantly filled up from debt flows, they are less than India’s external debt, a phenomenon which was not observed in the last decade or so,” Devendra Kumar Pant, Chief Economist, India Ratings, said.

Experts said that with global commodity prices coming off peaks, the RBI seems to be more comfortable with a modest pace of rate hikes.

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“India’s inflation problems are predominantly imported in nature. Hence, the recent reversal in several commodity prices is easing sequential inflation momentum. Recent commodity price declines offer the RBI some room to revise its inflation forecasts modestly lower amid stable growth signals. We expect monetary normalisation to continue, but see signs that the RBI is turning more comfortable with a modest pace of rate hikes,” Barclays India said in a recent note.

The Consumer Price Index or CPI-based inflation has been over 6 per cent for two straight quarters, remaining above the upper limit of the RBI’s medium-term target range of 2-6 per cent. Most of the risks to inflation are seen emerging from the crisis in the aftermath of the Ukraine-Russia war.

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With the inflation print expected to stay elevated in coming months, the RBI is one quarter away from having to explain its failure to keep the inflation within the stipulated band. As per the mandate by the monetary policy framework, if the average inflation rate breaches the 2-6 per cent target for three consecutive quarters, the RBI will have to explain to the government the reasons for breach in the inflation target.

“One of the reasons that RBI is intervening so heavily is because of imported inflation pressure and it has been a big driver of this particular inflationary cycle. The underlying domestic services inflation is actually relatively benign and a lot of these services, which are showing higher prices, are driven by imported components like public transport etc because of higher fuel costs,” Rahul Bajoria, Chief Economist, Barclays, said.

First published on: 20-07-2022 at 04:10:25 am
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