Indian rupee nears lifetime low: Where to next?

The Indian rupee dropped to an all-time low of 80.12 versus the dollar on Monday, 29 August2022 on bets the Federal Reserve will keep a restrictive stance for long. This is the second month where the currency has attempted to breach the psychologically important level of 80, prompting the Reserve Bank of India to step in.

RBI’s intervention did see the rupee appreciate since then, however it remain close to the lows and closed the last session at 79.79 on September 2, 2022. Since the dirham is pegged to the US dollar, the AED/INR rate also surged to as high as 21.81 before retreating to 21.72.

The rupee has depreciated around seven against the dollar this year, making expats who regularly remit money to India or individuals investing in Indian assets curious to know why the rupee has depreciated and what lies ahead. This article will highlight the factors responsible for the strength in the dollar, the fall in the rupee, what lies ahead and how investors can hedge their currency risk.

Why is the greenback in demand this year?

The dollar index, which tracks the dollar movement against a basket of six, climbed to 109.69, its highest level in 20 years and up by 14 per cent this year.

Firstly, it is essential to understand that the dollar is the world’s premier reserve currency and during times of uncertainty, investors rush into the arms of the haven asset. Ongoing geopolitical tensions, energy crisis in Europe, concerns over slowing global economic growth amid surging inflation, and aggressive rate hikes by the Federal Reserve have all contributed to the Dollar’s strength. To sum it up, higher short-term yields and risk aversion have boosted the Dollar.

Why is the rupee falling against the dollar?

The Indian rupee has been adversely affected by surging crude prices, trade deficit, heavy foreign fund outflows from the domestic markets, and strength in the safe-have dollar to a two-decade high. FIIs have pulled out over 30 billion dollars from the Indian equity markets this calendar year.

Nonetheless, the rupee has held up well against the Dollar compared to the performance of other major currencies, including the pound, the euro, and the Japanese yen.

Besides, FII flows have been picking up with August marking the first month on inflows this year as other Asian equities like China lagged. Moreover, India’s preliminary trade deficit for last month came in at $28.7 billion, a marginal pullback from the record $30 billion figure in July. The macroeconomic indicators of the economy are also sound: the most recent reading of industrial growth was 12.3 per cent year over year, marking the 16th consecutive month of surging activity; the PMI for services was 55.5, and both direct and indirect tax collections were substantial. The only primary cause for concern is imported inflation from energy prices. Given its dependency on oil imports, India has limited short-term options other than some local modifications (such as marginal tax cuts), all of which come at a cost.

What will happen next?

Both the government and RBI have taken measures to limit the outflow of dollars and encourage foreign fund inflows to curtail domestic currency depreciation. In an apparent effort to stop the devaluation of the rupee, the RBI has sold dollars from its forex fund. The week ending August 26 saw a $3 billion decline in India's foreign exchange reserves, bringing them to $561 billion, the lowest level in 20 months.

Vijay Valecha is chief investment officer at Century Financial. Views expressed are his own and do not reflect the newspaper’s policy.