NEW DELHI: The dollar index is at its highest level in two decades, reflecting the continued hikes in interest rates by the US Fed and the persistence of geopolitical risks.
Suman Chowdhury, Chief Analytical Officer, Acuite Ratings & Research, said: “Alongside the expanding trade deficit and current account, such an environment has kept pressure on the rupee which continues to hover around 80. FII outflows have been halted, uncertainty over capital flows and rupee volatility are likely to persist in the near term.”
Sujan Hajra, Chief Economist and Executive Director, Anand Rathi Shares and Stock Brokers, said that from 73 rupees per dollar in April 2021, the rupee recently fell below 80 rupees per dollar. The 6% depreciation of the rupee against the dollar over the past 12 months is one of the smallest among major countries (both developed and emerging), causing the rupee to appreciate against most others currencies.
Within Asian emerging markets, Indonesia, South Korea and India have historically shown the highest negative sensitivity to dollar strength. From a sector perspective for India, real estate and financial services have generally been the hardest hit, while healthcare has been the hardest hit, Emkay Global Financial Services said in a note.
With INR being a near outlier in the fall of FX in Asia, the FX intervention strategy for RBI will need to be reviewed. Emerging (strongly depreciating) bilateral imbalances against the CNY should not widen too much, he said.
“We believe that RBI will eventually let the exchange rate adjust to new realities, albeit in an orderly fashion, letting it act as an automatic macro-stabilizer of the policy reaction function. We see the INR bottoming out of 82 against the USD, before returning to the sub-79 range,” the report said.
Pankaj Pathak, fixed income fund manager, Quantum Mutual Fund, told the Jackson Hole symposium that US Fed Chairman Jerome Powell gave a hawkish speech suggesting that rate hikes will continue and that higher rates will be maintained for a long time.
Powell’s speech was a big setback for the part of the market that expected the Fed to cut rates at the first sign of economic weakness. Market expectations for the final US Fed Fund rate rose to 4% from 3.5% a fortnight ago.
Similar warmongering can be seen in comments from other central banks in this part of the world, including the European Central Bank, Bank of Canada and Bank of England. All increase their respective policy rates at a rate of 50 to 75 basis points at each meeting.
Pathak said it was not a conducive environment for foreign investors to invest in emerging economies. “Thus, we don’t expect massive inflows of foreign investors anytime soon, even if India is inducted into the global bond indices, although that would be positive for domestic investors and could prolong the bond rally for a while. some time.”
Hajra said the dollar’s broad-based strengthening against most currencies suggests that the rupiah’s depreciation is more due to dollar strength than rupiah weakness. Reasons for dollar strength include geopolitical uncertainties and rapid policy tightening by central banks in response to high inflation has made investors risk averse. The perception that the dollar is a safer currency in times of global uncertainty has increased the demand for dollars.
In response to higher inflation in the country, the US central bank is raising the policy rate faster than most other countries. The faster rise in interest rates in the United States relative to the rest of the world has increased the demand for dollars.
Reasons for the Rupee’s weakness include that every $1 increase in the price of crude oil per barrel results in a $2.5 billion increase in India’s annual oil import bill. With a significant rise in global crude oil prices, India’s oil imports surged, which pushed the rupee to depreciate, Hajra said.
Given global uncertainties, foreign portfolio investors withdrew $200 billion from major countries between January and March 2022. While countries such as the United States, France and Japan saw large withdrawals, $14 billion dollars were also withdrawn from India. So far in 2022, $29 billion has been withdrawn from Indian stocks by foreign portfolio investors. The large capital outflow also contributed to the weakness of the rupee.
However, the strength of the dollar is expected to end. The rapid strengthening of the dollar hurts the US economy by making exports uncompetitive and imports cheaper. The large trade deficit led US GDP growth to turn negative from January to March 2022. Even a limited decline in global uncertainty would weaken demand for dollars.
Moreover, oil prices have already corrected 15% from the peak. The U.S. Energy Information Administration expects crude oil prices to correct another 10-15% to $90 per barrel by the end of 2022. If the world oil price rises from recent high of $130 to $90 a barrel would mean potential annual savings. $100 billion on India’s oil imports. This would significantly reduce the pressure on the rupee to depreciate, Hajra said.
Whenever India has faced large portfolio stock outflows, they have been followed by large inflows. There are already signs that foreign investors are turning positive on Indian stocks. Even a moderation in foreign portfolio investment outflows would limit the rupee’s fall.
The RBI intervenes in the foreign exchange market to reduce the volatility of the rupee. As India’s balance of payments has turned unfavorable since the second half of 2021, the RBI has been selling dollars. This has translated into a limited depreciation (6%) of the Rupee over the last 12 months compared to a much larger depreciation (12-18%) of the Euro, Yen and Pound against the dollar.
With foreign exchange reserves of $580 billion, the fourth largest in the world, and a $50 billion long position in the derivatives market, the RBI is well prepared and determined to limit the volatility of the rupee, Hajra said.
Despite significant global volatilities, the Rupee has remained relatively stable over the past 12 months due to the RBI’s proactive policies. Likely changes in the global environment would make the rupee more stable over the next 12 months, he added.