As central banks continue to raise interest rates amid rising inflation, the US economy has seen a sharp inflow of funds, leading to the dollar strengthening against other currencies. This has increased worries in countries about further import of inflation on account of their dollar imports.
The rupee breached two key psychological marks this week — 81 and 82 against the dollar — as fund flows into US markets gathered pace following the Federal Reserve’s decision to raise rates by 75 basis points last week. While the rupee has lost 2.6% against the dollar this month, it has been among the more stable currencies in the current environment that has impacted, in varying degrees, almost all currencies and economies.
Thus, the Korean won has declined about 6 per cent against the dollar this month, and the British pound has lost almost as much. The Australian dollar has declined 4.8% this month, and the Swedish krona, Chinese yuan, and Philippine peso have fallen 4.6%, 4.1%, and 4.1% respectively. (See chart)
The 2.6% decline in the Indian rupee is comparable to the decline in the euro, which has lost 2.4% in September so far.
The decline has been primarily on account of outflow of funds, especially over the last six trading sessions. NSDL data show that over the last six trading sessions, FPIs have pulled out a net of Rs 18,279 crore from Indian capital markets, pushing the rupee down against the dollar. As more than 80% of this outflow, or Rs 14,890 crore, was from the equity markets, it also put pressure on the stock markets, leading to sharp declines.
“Risk averse sentiments due to heightened probability of global recession, higher domestic inflation, FPI outflows, depleting forex reserves and a widening trade deficit continue to weigh on the Rupee,” Madan Sabnavis, chief economist, Bank of Baroda, said in report.
The Sensex fell 5.1% over the last six trading sessions. Experts say that if inflation continues to rule high in the US and the Fed goes for a couple more rate hikes this year, continuing fund outflows may keep the pressure on equity markets and bond yields.
RBI has in the past intervened to limit the volatility and decline in the currency, but economists say the real concern now is inflation — especially food inflation — given that global crude and commodity prices have eased in line with concerns over slowdown in global growth.
The fact that brent crude has hovered around $90 per barrel for the last one month has brought relief to the Indian economy, capital markets, and the currency. When the tide turns, fund flows to the Indian economy and capital markets will be strong as India’s growth outlook is better than many others’.
The RBI is expected to raise interest rates by around 50 basis points in its monetary policy announcement on Saturday, primarily to address inflation concerns.
“We expect rates to increase up to 6-6.25%,” Sabnavis said. While the markets have already factored that in, it will be important to note RBI’s outlook on inflation and growth, which may drive investor sentiment in the debt and equity markets.
As fund flows are likely to continue until inflation in the US stabilises and the Fed continues to raise rates, equity markets are likely to stay volatile, and also see some correction. The rupee may see further depreciation against the US dollar.
As several market dynamics are at play, experts say investors should stick to the basics and not try to play in the market. Basics of asset allocation should be followed, and investments should continue through the SIP mode into equity markets, preferably through mutual funds.