Today the rupee breached the psychological 54 mark versus the dollar almost nearing its mid December 2011 record low of 54.30. Just to give you a peak into what, why and what next in terms of the rupee:
Data shows: Between FY 00 and FY 07, the rupee stabilized between Rs 44 - Rs 48/US$. Pre 2008 crisis it was faring well at Rs 39/US$. Between August 2008 and March 2009, it fell as much as 19.5% from Rs 41.89/US$ to Rs 52.18/US$ (rupee's worst ever rate then) only to recover spectacularly after that. Since 27 July 2011, rupee dipped by over 17% from Rs 43.95/US$ to Rs 52.73/US$ making it Asia's worst performing currency and taking it to an all time low of Rs 54.30/US$ in mid December. Since early March 2012, the rupee lost nearly 9% vis-a-vis the dollar. Yesterday the rupee plunged to 53.97/US$ and today it stood quite close to its mid - Dec record low at Rs 54.15/US$.
Theory says: The price of the dollar depends on supply and demand. As a result, when forex reserves increase, the rupee must move up and vice-versa.
Reality bites: The sharp decline in rupee has been associated with an increase in forex reserves especially since the second week of FY 13. This means theory hardly makes a convincing case when it comes to the way the rupee has behaved. This is because, the problems of the rupee are partly external and partly internal:
A common rationale for the falling rupee is the desperate scramble for a safe haven in times of crisis. Externally, fears about Greece's possible exist from the EU has made investors quite risk averse compelling them to dive into the ultimate safe haven - the US Dollar. The exit of Greece might have a domino effect on other weaker countries such as Portugal, Spain and Italy. If you compare a basket of prominent currencies, you'd find its not just the rupee but an array of other currencies which have been getting pummelled. Yesterday saw quite some shorting due to heavy demand for dollars. FIIs were selling equities across Asia and Asian currencies in other countries as well. Normally when the rupee touches the 54 mark, exporters come in to sell their dollars but this was not to be yesterday. Perhaps we think, exporters would sell off their dollars next week as per RBI guidelines to offload 50% of the dollars they hold in the Exchange Earners' Foreign Currency Account. This makes RBI the lone supplier of dollars. But this too might not continue to be the case especially when global trends have been pointing the other way. Another factor the RBI might be worried about is that India's import cover has been narrowing. In FY 08, the economy could finance for 12 months of imports but today this is down to 6 months making it difficult for the RBI to do too much to defend the rupee.
Internally, the twin deficit concerns - fiscal and current account deficit, moderating growth prospects, soaring inflation nos (April inflation stood at 7.2%) could possibly explain the weakness in the rupee. A rough trend analysis shows that the rupee fell by 6.8% post the announcement of Budget FY 13. The General Anti Avoidance Rule (GAAR) and the retrospective taxation measures announced in the budget, drove out foreign investment. While GAAR was no surprise the urgency to bring it to the table we think might have impacted sentiments adversely. Nevertheless, the government's decision last week to postpone the implementation of GAAR to 2013 could bring back FII funds but its impact on the rupee will have to be watched out for.
If the rupee falls? A falling rupee would increase the threat to inflation limiting RBI's freedom to cut rates, it would stem growth prospects, push up exports. A plunging rupee can prompt manufacturers of consumer durables as well as auto manufacturers to hike prices as many of them use imported devices. Infact the falling rupee could trouble even those who are set to holiday overseas with everything from food to shopping to sightseeing getting expensive.
What can be done? While other Asian countries' central banks typically intervene to bolster their currencies in times of weakness, the RBI used to prefer being a relatively passive player. Nevertheless, ever since late last year, the RBI to stem the slide in the rupee deployed a host of measures - It sold dollars, eased limits on bond market investment to attract foreign funds, directed exporters to convert upto 50% of their forex holdings with banks into rupees within a fortnight among other measures. While RBI's measures to enthuse NRI money and ECBs have been credible, external debt could mount higher as a counter effect. Last year RBI sold US$ 20 bn in the spot market to prop up the rupee. In addition to this, it sold dollars in the forward market with cumulative net forward sales reaching a high of US$ 3.23 bn in March 2012. But the RBI cannot be expected to continue selling dollars to save the rupee. Direct currency intervention employed indefinitely might lead to bigger problems. Also, while the RBI's intervention can only make a peripheral impact on the rupee, the government's role in stemming the sliding rupee could make a difference to the story - because this would mean fixing problems like the trade deficit, current account deficit, fiscal deficit, inflation concerns etc.
The loop holes?
- Oil price will continue to be a major IF. While the present calm in crude price trends gives comfort, it is quite difficult to correlate the same to subdued demand because as recently as last year, demand was subdued but prices soared.
- Current Account Deficit: At 4% of GDP in FY 12, CAD is definitely wide - which means greater demand for forex that what is being earned - casting a continued down side impact on the rupee
- Inflation: has been high coming in at 7.2% for April 2012. If the trend continues, it would limit the scope of the RBI to cut rates which in turn will affect economic growth. If the situation prolongs, investors might look for other emerging markets and with foreign money moving out of the country, rupee's value could fall further.
- Fiscal deficit: A key concern area - if subsidies are not capped at 2% of GDP in FY 13 as budgeted, they could cast reputational risks to the economy and bring down growth.
- Austerity in the EU might lead to deleveraging and curtail cap flows into the Indian economy thereby pressuring the rupee. With almost everyone scrambling to reach the safe haven, the rupee might face relentless pressure in the bargain.
In terms of where the rupee might go, the rumour doing the rounds is that a 57 - 58 showing by the rupee should not surprise. With its record mid December low levels just a whisker away, we think the rupee should stay volatile until sentiments stabilize making it a tough cookie.