The Indian rupee hit a fresh 15-month low against the dollar on May 08.
Despite the Reserve Bank of India (RBI) reportedly stepping in to stem the slide, the Indian currency hit a low of 67.17 to the dollar in early trade today, weakening from 67.13 yesterday. These levels were last seen when the economy was dented by an unprecedented demonetisation, and the future seemed uncertain like rarely before.
In the last five years though, the currency has tumbled down to these levels, or weaker, at least twice. Three years before the rupee was roiled by demonetisation, it had seen similar levels at the end of a historic rout in emerging-market currencies in 2013.
There was a period of about a year when the rupee shuttled between 66 and 69 against the dollar in 2015-16, around the time Britain voted to exit the European Union i.e. the “Brexit”. The vote had rattled global investor sentiment, hurting emerging economies like India the most.
Does the rupee’s recent spiral signal a calamity, yet again, for Asia’s third-largest economy?
The sell-off in the rupee in each of the earlier periods featured a few common characteristics that hold true today: an economic slowdown and fear of wider budget deficit in India, a sharp spike in US economic growth, and global money managers turning averse to the risk in emerging markets.
Now, added to the list is a spike in crude oil prices that by itself can derail India’s finances.
Benign crude oil prices had been a big bonus for the Indian government in recent years and the advantage is now slipping away.
American crude oil prices topped $70 per barrel on May 07 for the first time since November 2014.
The outlook for US economic growth is robust and that will only mean more demand for gasoline, possibly leading to even higher demand and prices for crude oil.
The Indian crude basket, the weighted average price of all the country’s crude oil imports, has gone up from $52.49 in April last year to over $63 in March 2018, a rise of 22% in a year, according to government data.
The weakening rupee will be a double whammy for India as the country imports nearly 80% of all the crude oil it needs. A weaker rupee would mean the country would have to pay more than it did earlier to get the same amount of imported substances, including oil.
The spike in import bill would certainly strain the country’s finances, especially when the contribution of exports to the gross domestic product (GDP) is at a 14-year low.
One of the big reasons why traders are bearish on the rupee is that the government is expected to reveal the highest current account deficit in six years for the financial year ended March 2018, according to an April report from Kotak Economic Research.
The current account deficit is the shortfall in dollars earned compared to those spent by a country in the transactions with its trading partners. So, the wider the deficit, the more dollars a country has to buy in the market to pay its bills. That, in turn, dents the value of the local currency further.
The rise in oil prices since March 2018 will only worsen the deficit going forward and that would mean that the rupee may be trapped in a vicious cycle of devaluation.
The questions on growth
While India is expected to grow anywhere between 7% and 7.5% in the financial year 2019, the fastest for any major global economy, there are significant doubts.
“There can be only four drivers of growth (public expenditure, consumption, private investment, and exports),” the chairman of the prime minister’s economic advisory council, Bibek Debroy, told Quartz in an interview in February.
While Debroy is more optimistic about India’s growth, the details are patchy. Private investments and exports are abysmally slow, while consumption growth is uncertain. India is scheduled to vote for its next government in 2019, but that might not make much of a difference either. “History doesn’t suggest any drastic jump in the overall volumes of the consumer companies in the year preceding the election year,” financial services firm Jefferies argued in a March report.
Public expenditure, the only strong spoke in India’s economic wheel, can be limited in function by the rising deficit. The government, with its stretched finances, cannot endlessly borrow to fund growth.
While a weaker currency is expected to help exporters, it may also increase their input costs. Many exporters in India import raw material, add value, and export it to other markets around the world. The advantage of a weaker currency is limited for those players.
Moreover, other currencies from the emerging world, too, are weakening alongside the rupee. So, the competitive advantage for Indian exporters will be limited at best.
The dollar deficit can be offset if other sections of the economy, like the capital markets, draw money from global investors.
However, global investors are pulling out money from emerging markets like India. In April alone, India lost over $2 billion in foreign portfolio investments (FPI), the highest outflow in 16 months. FPI are the dollars invested in buying shares or debt of existing companies.
Moreover, for the first time since 2015, India has slipped out of the top ten global destinations even for foreign direct investments (FDI), the money that foreign firms invest in buying or setting up assets, instead of just buying shares or debt of existing companies like in FPI.
This aversion to emerging countries has been the most common factor, every time in the last five years, when the rupee has slipped down to its current levels or below.
With the odds stacked heavily against it, the rupee is expected to weaken further. Most global brokerages expect the rupee to slide to 70 against the dollar and that will only exacerbate the pain in the economy.