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The Indian rupee is on a downward spiral and touched a historical low of 80.06 last week weighed by a host of factors. Since the start of this calendar year, the domestic currency has fallen by more than 7% against the U.S. dollar. This is not the case with USD-INR currency pair alone. Even the historically strong euro and the pound fell more than the Indian rupee against the US dollar. This has resulted in the Indian rupee appreciating against the euro and the pound.
However, the current decline in rupee against the US dollar, has been relatively lower compared with previous crisis like the Taper Tantrum in 2013, when the rupee had depreciated by over 11% in seven months from the start of the crisis in May 2013 and the global financial crisis in 2008 as the rupee depreciated by over 20% between December 2007 and June 2009.
Since the war between Ukraine and Russia started, price of various commodities have sky rocketed. It has led to soaring crude prices amid rising global inflation and various central banks taking measures to tighten the global money supply. India which imports 80% of its crude had to shell out more dollar that weighed on the rupee.
In addition, India’s trade deficit has widened significantly as imports are always higher than exports. For instance, in financial year 2022, according to the RBI’s provisional data, India’s current account deficit jumped to $38.7 billion from a surplus of $23.9 billion in the previous fiscal. As the current account deficit widens, it needs more dollars to pay for the imports and it should convert more rupees into dollars, resulting in more demand for the the US dollars. The US dollar has been the reserve currency of the world as the currency is considered a safe haven for investors during bad times and nearly 70% of the world trade transacts in the US dollars.
Besides, Foreign Institutional Investors have offloaded massive amounts of dollar from the Indian markets and further put pressure on the domestic currency. In 2022, FPIs have sold about $29.6 billion in Indian equity and debt instruments. As the inflation in the US hit 40-year high, the US central bank raised interest rates to tame retail inflation in their country. This move by the Federal Reserve have made the US treasury notes and bonds attractive. This has led to investors scrambling for the US dollar and have been dumping Indian scrips after a strong rally in Indian markets for nearly 20 months.
Recently, the Fed has increased the key interest rates by 0.75% for the second time, but the comments by Fed Chairman Jerome Powell have eased some investor concerns about the pace of rate hikes. As many analysts have been predicting a looming US economic recession, which has been acknowledged by the Federal Reserve Chair himself, the US central bank is likely to slow down the pace of monetary tightening is the coming months.
Meanwhile, the RBI has been aggressively defending the rupee after it crossed 80 per US dollar mark through sales of the greenback from its reserves. In the last few weeks, the RBI has been actively present in the spot market to ensure that there is no excess volatility or steep depreciation in the rupee.
However, the rupee is expected to remain under pressure in the near-term because of global uncertainty, continued war in Europe, elevated commodity prices, rising interest rates and a possible recession in the US as well as in Europe affecting the global economic rebound after the severe pandemic.
To read more on inflation, click here