The rupee fell to a low of 79.15 to the US Dollar (rates as on 1st August 2022), a week after India’s trade deficit hit $25.6 billion in June, higher than $24.3 billion in May caused due to rise in crude oil and coal imports.
The rupee fell as FIIs withdrew their funds amidst tightening monetary conditions globally. As a result, the foreign portfolio equity outflow per NSDL data was ₹7,432 crore in July 2022, slower than its sell-off of ₹31,430 crores last month from 1st to 18th. As a result, the current account deficit could touch 3.2% of India’s GDP, higher than 1.2% last year.
The sharp sell-off in EUR-USD due to fears of recession has sparked a risk-off movement in equities globally. The fall in equities and firming dollar index caused the rupee to depreciate against the dollar. The widening CAD may continue to increase the fall of the rupee, though the FDI and investment inflows could somewhat offset the effect.
Why did the INR depreciate – reasons?
There is a difference between the US, a developed country, and India, a developing country. Thus, there is a significant gap in the rupee-dollar purchasing power. Although, in recent times, INR has been depreciating further. The reasons behind the INR depreciation are –
High Crude oil and raw material prices: The Russia-Ukraine war has been another factor affecting the global economic shock. It has led to inflation and has affected most countries. India is a key importer of crude oil. The global oil prices sky-rocketed at the beginning of 2022 by 60%. As a result, the cost of imports for Indian companies increased.
Moreover, the import bills for commodities, especially raw materials and coal have increased. These reasons mean higher demand for dollars than INR, further weakening the purchasing power of the rupee.
FIIs exiting Indian investments: With factors such as the US Fed meeting and the Russia-Ukraine war, overseas investors are leaving the Indian market. Sticking to a stable economy or a developed country in such a phase seems safe. When investors exit the Indian market, the demand for US dollars increases, and INR decreases, causing depreciation in the Indian rupee.
Higher rate of returns in USD: Investors believe in the sole mantra of higher returns. In recent years, India incurred losses due to the pandemic and other conditions that still must be compensated. The Reserve Bank of India (RBI) has also taken measures to ensure foreign currency inflow. But the bond yield offered by the USA is high. Thus, many investors tend not to invest in Indian markets.
US Fed Meeting: The US Fed meeting took place on 26th and 27th July 2022. The Federal Reserve hiked the benchmark rate by 75 basis points in the same session. While it was an expected move, it still caused a global impact. Such an increase affects banks, businesses, individuals, and the entire economy, leading to inflation and further depreciating INR value.
On a micro level, a devaluing rupee affects a person’s purchasing power. Although on a macro level it involves various sectors, industries, and economies.
As INR is depreciating, things are getting expensive, causing inflation. So let us understand the rupee’s impact on inflation.
Impact of Rupee devaluation on Inflation: The weakening Indian rupee directly impacts inflation, affecting the purchasing value of the rupee compared to other currencies. Therefore, the first step is decreasing imports as they are expensive. Not doing so would result in rising inflation.
One of the factors that caused a significant impact is crude oil. The prices of crude oil are at an all-time high, and India imports about 60% of it. These prices have created a short-term negative effect and affected the GDP. In addition, inflation has affected consumer electronic commodities too. CRISIL expects the Consumer Price Index (CPI) inflation to rise to 6.8% from the previous fiscal expectation of 5.5%.
As we know, a small shock in one country can affect the markets globally. So, are you wondering what is happening to the US GDP as the dollar gains strength?
How has the strong dollar affected the US GDP?
USD is one of the strongest currencies across the globe. As a result, it became the world’s first reserve currency. Central banks across the globe hold their reserves up to 59% in US dollars, according to the International Monetary Fund.
The dollar keeps getting stronger and is 15% higher than a basket of currencies. It has wreaked havoc, driving up food imports, deepening poverty globally, fuelling a loan default, toppling a government in Sri Lanka and sparking a spate of losses in the equity and bond markets for investors the world over. That’s not all; the 75 bps hike last week could sink the US and other global economies into recession. The US economy contracted 0.9% in the Q2 CY22.
INR and USD have an inverse relation. If the US dollar increases, INR weakens, and vice versa, having a similar effect. Such a change mainly affects imports done by Indian companies. Although another impact is on business people, as it affects global borrowing, making it expensive. The overall effect is seen as the country’s GDP slows down.
How is the devaluation affecting business, imports and exports?
Overall, rupee depreciation affects all the sectors in an economy. However, exporters may not be affected much as they earn more in dollars when the currency depreciates. On the other hand, importers will find their import bills increasing. The table below explains the effects of depreciation on different sectors.
|S No.||Name of the sector||Impact on the sector||Reasons|
|1||Information Technology (IT)||Positive||Billing happens in USD|
|2||Pharmaceuticals||Positive||Net exporter of products|
|3||Garments/ Fashion||Positive||Net exporter, input cost is localized|
|4||Oil & Gas||Negative||Imports ~85% of oil consumed in the country|
|5||Consumer Electronics||Negative||~50% of total inputs are imported|
|6||Aviation||Negative||Fuel cost is increasing, negative|
|7||Tea||Positive||16% of total production is exported|
|8||Renewable energy||Negative||Import of solar cells|
|9||Metals||Positive||10-15% is exported|
|10||Auto||Negative||Input RM is imported, making price of cars more expensive|
|11||FMCG||Negative||Input RM is imported|
Should you be worried about the devaluation?
Despite the slide against the strengthening dollar, the Indian rupee is one of the best currencies in the emerging markets. A DBS report found India stood 7th among the best performing 19 currencies that depreciated against the USD.
What’s more, with the dollar index weakening, foreign institutional investors showed signs of investing in Indian equities after nine months of sustained selling. NSDL data showed foreign portfolio investors’ net outstanding purchases in India were $618 million in July.
The RBI is trying to slow down the decline beyond all-time lows. To help with the same, RBI has sold dollars to limit losses. During such phases, exports seem economical, although there has been weak global demand and volatility that does not support the same.
Will the RBI hike the interest rates by 40bps next week? We will have to keep an eye on the news. In the meanwhile, consider investing in stable stocks for the long term.
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