US yields, inflation key triggers: Rupee dips to new low against dollar

The rupee drifted down to its lifetime lows on Monday, hitting 77.44 against the dollar in what currency experts described as a ‘catching –up’ move. The Indian currency has been holding up relatively well against the strengthening dollar index (DXY) vis-a-vis its peer currencies. The immediate trigger appears to have been the sharp spike in yields on US treasuries to 3.1% and fears that inflation would remain high.

There is also concern the Reserve Bank of India (RBI) may not be able to support the currency much longer as it has been doing.

“The forces that have pushed the dollar higher remain ever actively in play. Indian interest rates will rise less – and, possibly, much less – than US rates over the next 12-18 months, which translates to more pressure on the rupee,” forex expert Jamal Mecklai wrote last week in FE.

Despite a rising trade deficit since September last year and large FPI (foreign portfolio investors) outflows, the rupee has lost relatively less value, due to intervention by the RBI. Since November 2021, FPIs have pulled out around $25 billion while the reserves have fallen by around $45 billion.

Madan Sabnavis, chief economist at Bank of Baroda, said the rupee is still somewhat overvalued compared to its peers. “So, there is some reason for the rupee to depreciate further,” he said, pointing out that the RBI has intervened to the tune of some $15 billion and also in the forwards market. “If the rupee does not move up to around `77/$ in the next couple of days, the 78 level will be tested,” he added.

Since January 2021, the DXY has put on some 14% while the rupee, before Monday’s fall, had lost some 4.5%. Jayesh Mehta, country treasurer, Bank of America, said the rupee has not depreciated as much as its peer currencies in recent months because foreign direct investment flows have been strong and it looked like crude oil prices would not go up beyond a point. “So, there was a belief the current account deficit would be reined in within 3%. Now, given our dependence on imported crude, the uncertainty on oil prices is worrying, the dollex is less of a concern,” Mehta observed.

One reason experts are not overly concerned about Monday’s dip in the currency, unlike in 2012 and 2013, is that companies do not have a significant unhedged ECB (external commercial borrowings) exposure following the tightening of norms for dollar exposures. They also point to the RBI’s stash of reserves of close to $600 billion of reserves plus an estimated $40-50 billion in the forward markets appears adequate.

Anindya Banerjee, vice president, Kotak Securities, said while the forward premium has increased since the repo rate hike last week, importers generally don’t hedge much given the cost. “While there have been episodes of volatility in the last few years, external risks such as unhedged ECB exposures have been largely contained,” he added.

Banerjee believes the interest rate hikes would support the currency though the rupee could touch 78.00-78.50 against the greenback over the next one month.

However, India’s trade deficit driven up by costlier imports of crude oil, coal and palm oil has averaged $20 billion over the last six months, and is worrying. The CAD, some believe could even cross 3% in FY23. Indranil Pan, chief economist, Yes Bank, cautioned chances of oil prices falling too much appear slim. “Our sense is the trade gap and current account gap would widen in FY23. Also, now the Chinese yuan has started depreciating quite sharply and this could result in a seismic shock via other Asian currencies into the rupee,” Pan explained.

Analysts believe a weaker currency may not be sufficient to boost exports given the expected slowdown in global trade. As per the RBI, India’s real effective exchange rate (REER), based on a new 40-country series, is also at an elevated level, and a decline may help.

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