Depreciating the Indian currency would make servicing imports much costlier.

The gradual decline of the Indian currency this calendar year continues as Indian National Rupee (INR) plunged to close at a record low of 79.07 against the dollar on Tuesday, 28 June 2022. From the last week itself, the rupee has depreciated around 1.2% from 77.93 on Monday 21st June. The INR has depreciated by more than 6% in this calendar year from 74.31 on 3rd January 2022. At the time of writing this article, the INR was trading at a new record low of 78.95 against the dollar. ?

Tightening monetary policy, unwinding of carrying trade, and rising crude oil prices ?

?The NSDL data on Foreign Portfolio Investor statistics shows that India in this calendar year has lost more than USD 29 billion as Foreign Portfolio Investment (FPI) outflow. This outflow of capital is what is termed the unwinding of carrying trade. A carry trade is an investing strategy that involves borrowing in a country with a low-interest rate and investing in another country that provides a higher rate of return. During the pandemic, major economies around the world were easing out liquidity and interest rates were low in major economies such as USA and EU.?During this period India received around USD 36.1 billion in portfolio investments. Now amidst rising inflation USA Federal Reserve had till now increased the policy rate by 150 basis points (bps) and a further increase of 50-75 bps points is expected in the month of July, India is now comparatively being less favored by foreign portfolio investors. This outflow of capital means more demand for the US dollar against INR and thus depreciation of INR value.

Another major factor affecting the value of INR is the rising crude oil prices. India is among the largest importer of crude oil in the world sourcing more than 80% of its total oil consumption through import. In FY 2021-22 Petroleum products accounted for over 31% of India’s total imports.?A 2019 research report of RBI estimated that every USD 10 dollar in oil price raises headline inflation by 49 bps and Current Account Deficit (CAD) to GDP by 0.5%. The rise in trade deficit means more USD is demanded by Indian importers exerting downward pressure on INR

Impact on MSME

?In theory, depreciating currency makes domestically produced goods more price-competitive in domestic and as well in the global market. A low-value domestic currency would make export cheaper and import costlier. This theory would not hold true for India as it is dependent on imports for most of its raw material requirements such as fossil fuels and some important minerals. Depreciating currency would make importing such key raw materials negatively impact the profit margins of already stressed MSMEs.

Conclusion

We expect the Indian currency to weaken further and for the first time ever cross the USD 80 dollar mark by July this year owing to the scheduled US Federal Reserve meeting on 26 July 2022 where a policy rate hike up to 50-75 bps is expected. Depreciating INR would make servicing the widening trade deficit much more costly and if the trend continues in the medium to long term, it can raise some serious challenges to India’s macro-economic stability.

RBI's timely intervention in the forex market is providing some cushions but it cannot prevent the gradual decline of INR. India is majorly vulnerable due to its massive and growing CAD. Proper management of certain commodities being imported which are either domestically available such as coal or reducing import of gold, which is led by speculative demand for this commodity amidst rising inflation, is the need of the hour.??