Why the rupee at 80 against the US dollar may not be bad news?

Russia’s invasion of Ukraine added fuel to the ongoing rush. Global investors, who were already withdrawing money from developing nations to park them in the US, frantically started pulling out the capital. Aggressive rate hikes by the US to tame inflation made the dollar more attractive.  

The dollar index, which tracks the US unit against a basket of major currencies, rallied 11% this year to a two-decade high -- causing persistent depreciation of currencies around the world. 

As a result, the Indian rupee breached the psychological mark of 80 against the US dollar to hit a record low for the seventh 
 

One of the main reasons cited by Finance Minister Nirmala Sitharaman for the depreciation of rupee was the capital outflow. Foreign portfolio investors (FPI) have sold shares worth more than $30 billion so far in 2022. The widening trade deficit also leads to depreciation pressures on the exchange rate.

India’s trade gap also widened to a record high of $26.18 billion in June as the country’s economic recovery meant higher non-oil as well as oil imports. The RBI has been intervening to defend the rupee against any sharp volatility and ensure orderly depreciation, leading to forex reserves plunging to a 15-month low of $580 billion as of July 8.

Performance of major advanced economy currencies against USD in 2022

While the rupee has lost nearly 7% in 2022, currencies of some advanced economies fared much worse. The Euro is down 13%, British pound 11% and the Japanese yen 16%. As a result, rupee has appreciated against these currencies. 

The rupee lies at the middle of the pack among its Asian peers. The South Korean won, Phillipine peso, Thai baht and Taiwanese dollar have fallen more than the rupee against the US dollar.

A weaker rupee can help India’s exports become more competitive. But by one measure, rupee is still overvalued. The 40-currency real effective exchange rate or REER, which shows the currency’s competitiveness against a basket of its trading partners, stood at 104.18 in June as against 104.78 in May. A value over 100 signals overvaluation.

Swati Arora, Economist, HDFC Bank says we see further downside to rupee going forward. This will impact inflation and widen CAD, she says. Weaker rupee will help in protecting only some export competitiveness.

Historically, it is seen that India’s exports respond more strongly to changes in global growth vis-à-vis currency movements, economists at QuantEco research wrote recently. The impact of rupee depreciation is varied across sectors. Pharma industry insiders say it is likely to be largely neutral and the benefits may be offset by rising input costs.

India’s pharma sector exported drugs worth $22.5 billion in FY22. Companies drawing highest share of revenues from US

The textile industry, which is a net exporter, will benefit from a weaker rupee but industry sources say that the gains may be short-lived as customers will demand revised rates in upcoming orders. As for the gems and jewellery sector, the depreciation of rupee is giving a cost advantage for its units.

The IT services and technology industry will be among the biggest gainers of a depreciating rupee as US contributes more than 50% to its revenues. 

Meanwhile, tourists and students going to the US will have to shell out more. But students who are currently studying in the US and plan to secure a job that pays in dollars will gain.  On the other hand, rupee’s appreciation against euro can help outbound travel to European countries. But high oil prices and strong pent-up demand has led to a steep rise in international airfares. International tour costs are already up by as much as 50% compared to 2019.  

Devendra Kumar Pant, Chief Economist, India Ratings and Research says forex reserves falling below external debt is worrying. Strong global demand is more beneficial for exports than weak rupee, he says. In volume terms, export growth may not be as strong as last year. Stemming capital flight is crucial to ease downward pressure on the rupee.

Also, slowdown in global demand amid recession fears in the US and Europe can wipe out whatever gains Indian exporters may see due to a weaker rupee. The IMF in April cut the global GDP growth forecast to 3.6% and in its upcoming review next week, the fund is set to downgrade the forecast substantially. Exporters in sectors like IT and pharma will gain from a weaker rupee but export sectors where the import intensity is high will see further pressure on input costs.