Volatility in Rupee/ Weakening of Rupee

03 Oct 2022 Volatility in Rupee/ Weakening of Rupee

Source: The Hindu; The Indian Express

News: To tackle inflation the US Federal Reserve has hiked its interest rate leading to strengthening of the dollar against other currencies. Rupee also breached psychological marks of 81 and 82 against the dollar.

Current economic scenario across the globe in September: 

• The Korean won and British pound have declined 6% against the dollar.
• Decline in the Australian dollar is 4.8% this month.
• Respective fall in Swedish krona, Chinese yuan, and Philippine peso is 4.6%, 4.1%, and 4.1% respectively. 
• Similarly, the decline in the Indian Rupee is 2.6%.

Reasons for weakening of rupee vis-à-vis dollar:

• Risk averse sentiments in the market due to heightened probability of global recession.
• Higher domestic inflation especially food inflation: Compared to August 2021,Consumer Price Index (CPI) is up 1.70% from 5.30%, and Wholesale Price Index(WPI) is up 1.02% from 11.39%.
• Foreign Portfolio Investment(FPI) outflows: Outflows of approximately Rs.18,279 crore from Indian capital markets over the last six trading sessions.
• Depleting forex reserves: Due to Reserve Bank of India’s intervention in the currency markets.
• Continuous widening of trade deficit: India recorded a current account deficit of $23.9 billion or 2.8% of GDP in the first quarter or Q1 of this fiscal year(FY23).
• Consecutive hiking of interest rates by the US Federal Reserve for the third straight time and there is expectation in the market that interest rate will rise further.
• Geopolitical uncertainties due to the Ukraine war and volatile energy prices.

Impact of fall in the rupee:

• Sustained fall in rupee will create stress in pockets with rise in household expenses.
• High import costs/bills and will negatively impact companies which pay foreign companies royalties for franchises in India.
• Depreciation of rupee will partly help the export sector, as exports are influenced by global demand and currencies.
• Auto, real estate, infrastructure sectors, travelers and students studying abroad  would be worst hit with fall in rupee.
• Rupee’s fall will have a positive impact on the IT and banking sector.

Response of Reserve Bank of India(RBI) to smoothen the decline of the rupee:

• Intervention in the forex market by RBI: Due to RBI’s action there is dip in Indian foreign exchange reserves.

Issues associated with RBI’s intervention in the forex market

• Chances of burning out forex reserve in case of aggressive interventions.
• By managing exchange rate RBI is going beyond its mandate as RBI’ s main mandate is price stability through inflation containment.
• Reflects short-sightedness on part of RBI: In most cases, overshooting of the currency gets corrected after the event is over. So. instead of steering the currency in any direction, the aim should be to ensure that volatility is not too high.

Way forward:

• Since the exchange rate is market-determined. So, let the market forces play out.In the current economic scenario such as strengthening of dollar and deterioration of current account deficit, the RBI should limit its interventions in the currency markets allowing  the currency to adjust by itself. RBI should intervene only if the rupee is on a sustained free fall.
• RBI should address the real concern i.e. inflation as the current situation is favorable due to ease in global crude and commodity prices. Recently in its monetary policy announcement, we believe the RBI hiked the interest rate by 50 basis point.
• RBI should focus on a multi-pronged approach to increase the supply of U.S. dollars in the Indian market such as easing provisions for remittances, allowing short-term foreign portfolio investments in government securities,etc and RBI should also introduce schemes to attract NRI investments.
• Major policy tool that RBI should use is bridging the interest rate differential through interest rate defence as managing volatility can  give a panic signal to the market.
• Long-term solution: Finance the Current Account Deficit (CAD)with capital inflows, and prevent hot money outflow with the aid of interest rates.

Article:

1. The Indian Express: Let the rupee fall; Volatile INR still relatively stable; what now?
2. The Hindu: How much should India prop up the rupee?

Article Link:

1.https://indianexpress.com/article/explained/volatile-inr-still-relatively-stable-what-now-rupee-fluctuation-8181361/ 

2.https://indianexpress.com/article/opinion/editorials/let-the-rupee-fall-8167354/ 

3.https://www.thehindu.com/opinion/op-ed/how-much-should-india-prop-up-the-rupee/article65950618.ece 

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