Weakening of the Indian rupee, hitting new lows amid global headwinds

Two thousand rupees displayed with the Indian flag in the background.

Manish Rajput | SOPA photos | LightRocket via Getty Images

The Indian rupees It came under intense selling pressure from a perfect storm of global headwinds that analysts say will continue to hit the currency in the coming months.

In recent weeks, the Indian currency It tested record lows and breached the Rs 80 level per US dollar at least twice in July, only recovering after the RBI intervened to stem the slide.

The currency has since regained some strength and was around 79.06 per dollar on Thursday.

The recent sharp declines prompted a quick response from policy makers to allay concerns about selling the rupee, which could lead to lower prices.

Finance Minister Nirmala Sitharaman attributed the depreciation of the rupee to external causesin a written statement to Parliament in late July.

She said that global factors such as the ongoing Russian-Ukrainian war, rising crude oil prices and tightening global financial conditions, are among the main reasons for the weakening of the Indian rupee against the dollar.

Analysts agreed that the currency is taking a hit from several fronts globally.

Energy price hike

Preliminary data from June showed India’s supply of Russian crude reached nearly 1 million barrels per day, up from 800,000 barrels per day in May, according to investment advisory firm Again Capital.

said Adarsh ​​Sinha, co-head of Asia Pacific and exchange rate strategy at Bank of America Securities.

“Oil imports from Russia, if settled in rupees, will reduce the demand for dollars from oil importers. These rupees can be used to settle payments for Indian exports, and/or invested in India – both of which can be beneficial,” he told CNBC.

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In July, India’s central bank set up a mechanism for International trade settlements in Indian rupees. Analysts said the measure would allow traders to bill, pay and settle imports and exports using the Indian rupee, which would help achieve a long-term goal of internationalizing the Indian currency.

“This move is constructive for the rupee in the medium term as the INR rises.” [Indian rupees] Demand for settlements means lower demand for forex for current account transactions,” Radhika Rao, Vice President and Economist at DBS Bank, said in a Recent note.

This will facilitate “trade with neighboring countries, with trading partners who are unable to access dollar funds and/are temporarily outside the international trade mechanism and those looking to expand their trade settlement currency pool,” she wrote.

Transfers remain flexible

While the weak rupee is putting pressure on India’s imports from other countries, this may help boost the country’s remittances from abroad.

Remittance flows to India grew by 8% to reach $89.4 billion in 2021, based on the recovery in the United States, which accounts for a fifth of the country’s remittances, According to World Bank data.

“Remittances can be determined by many factors but [a] “A weak rupee helps increase the local value of those remittances, which will help offset the inflationary pressures for the beneficiaries,” said Sinha of Bank of America Securities.

Goldman Sachs also said in a recent note that remittances to India “should remain resilient against the backdrop of stable economic growth in the Middle East, benefiting from higher oil prices.”

Impotence problems

However, analysts cautioned that India’s growing current account deficit is expected to remain a persistent drag on the rupee, which is exacerbated by large capital outflows.

“India’s external balance sheets are deteriorating, driven by the terms of trade shock from higher commodity prices, which has led to a wider current account deficit,” said Santano Sengupta, India economist at Goldman Sachs.

A current account deficit occurs when a country’s imports exceed its exports.

He added that in the unfavorable market environment for emerging market portfolio inflows, “we estimate a large balance of payments deficit. This means continued low foreign currency reserves across the spot and forward books held by the Reserve Bank of India.”

With global capital inflows drying up in the Fed’s tightening cycle, US recession risks at the fore, and India’s external balances becoming challenging, we are likely to see continued weakness in the INR going forward.

Santano Sengupta

Indian economist, Goldman Sachs

According to Nomura’s latest note, Indian stocks already saw $28.9 billion in net foreign outflows year-to-date in July, the second-largest number of Asian economies, excluding Japan.

But India’s large external barriers “have provided confidence in the ability of the Reserve Bank of India to prevent tail risk scenarios from spilling over into domestic interest rates and impacting growth further when it is already in a rough patch due to higher commodity prices and supply disruptions, along with monetary policy tightening”, Sinha said.

“Our balance of payments deficit forecast indicates a deficit of $30-50 billion this year. The Reserve Bank of India has sufficient reserves to continue intervening for at least another year,” he added.

In an effort to defend the rupee, the central bank has recently announced a set of measures aimed at encouraging capital inflows. Measures include loosening regulations on foreign deposits, loosening rules on foreign investment flows into the debt market and offshore commercial borrowing.

Tantrum

Despite the current weak performance of the rupee, the currency’s decline remains more contained today compared to the “taper tantrum” in 2013, analysts said, citing better fundamentals this time around.

At the time, the Federal Reserve’s decision to scale back its extraordinary monetary stimulus triggered a sell-off in bonds, driving up Treasury yields and boosting the US dollar. This led to an exodus of money from emerging markets.

“Many of [the Indian rupee’s] DBS’s Rao said in a recent note, explaining that the interest rate differential between the dollar and the rupee is rising as interest rates continue to rise in the United States.

She added that the pressure to defend the devaluation of the rupee is not as high as it was during the tapering tantrum. She wrote that should pressures intensify, the government has options such as delaying the purchase of massive defense items that would help reduce the demand for dollars.

Analysts also argued that India’s offshore balances, which are often cited as a source of weakness, have some inbuilt buffer against further depreciation risk of the rupee.

“So far, even in the face of deteriorating external balances, the stock of foreign exchange reserves has been limiting the weakness of India’s external sector, allowing a slow depreciation of the Indian rupee (against the US dollar),” said Goldman Sachs’ Sengupta.

From now on, with foreign exchange reserves depleted, and real spreads narrowing, the risks of external weakness in India will increase – although it will likely compare better than a ‘taper tantrum’.

Could the rupee drop to 82 per dollar?

Analysts said that as global conditions remain volatile, the rupee will face more downside risks in the coming months.

“With global capital inflows drying up in the Fed tightening cycle, US recession risks ahead, and India’s external balances becoming challenging, we are likely to see continued weakness in INR going forward,” said Goldman Sachs’ Sengupta.

As a result, the bank expects the Indian currency to be around 80-81 rupees per dollar over the next three to six months, “with risks tilting towards further weakness in the event of a sharp dollar strengthening,” he added.

Other analysts expect that the rupee will test fresh new lows in the near term.

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Craig Chan, Head of Global FX Strategy at Nomura, said he doesn’t think the 80 level is “holy”.

“We don’t believe there is any particular market positioning factor that would trigger an accelerated appreciation of the US dollar against the Indian rupee if it breaks 80 – unlike in 2013,” he added, referring to the “gradual tantrum” period. Our last call was INR [rupee] It risks breaking the 80 level against the dollar and exceeding it to 82 by the end of August.”

Sinha from BofA Securities expects the Indian currency to reach the 82nd level by the end of 2022 due to continued volatility in the global environment.

“However, we see the risks of a larger devaluation contained in RBI’s extensive stock of reserves,” he said.

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