The rupee’s decline to a historic low of 81.09 to the dollar will make it more costly to import crude oil and other goods, which would further increase inflation, which has been beyond the Reserve Bank’s upper tolerance range of 6% for the previous few months.
The pressure on the local currency, which is mostly brought on by the US Fed’s frequent interest rate rises, is anticipated to remain strong as the trade gap widens and institutional investors gradually remove their capital.
The Reserve Bank of India is anticipated to raise the repo rate, or short-term lending rates, by 50 basis points in an effort to reduce inflationary pressure when it announces its bi-monthly monetary policy later this week. A falling rupee has an impact on local fuel prices in a country where imports account for 85% of its oil consumption and 50% of its gas needs.
India’s trade imbalance more than quadrupled to USD 27.98 billion in August as a result of an increase in crude oil imports. The amount of “petroleum, crude, & products” imported in August of this year was USD 17.7 billion, an increase of 87.44 percent over the same month last year.
For the week ending September 16, India’s total foreign exchange reserves decreased by USD 5.219 billion to USD 545.652 billion. In the previous week, the reserves decreased by USD 2.23 billion to USD 550.87 billion, continuing a downward trend as the central bank uses its resources to protect the rupee from pressure mostly brought on by overseas events.
In a research, SBI stated that while declining in June from record highs, global commodities prices have remained volatile. Prices gradually increased from late July to early August before beginning to decline at the month’s conclusion, primarily due to worries about a potential slowdown in demand.
Due to predictions of an impending decline in global demand, crude oil prices are currently trading significantly below USD 100 per barrel with increased volatility, the report added. According to Aditi Nayar, chief economist of ICRA, “a falling INR will partially negate the advantage of decreased commodity prices on inflation.”
The cost of imported edible oils would increase, according to B V Mehta, executive director of the Solvent Extractors’ Association of India. Every year, the nation imports roughly 13 million tonnes of edible oils. “Consumers will eventually pay for this. The one bright spot is India’s exports of oilseeds, though. The weakening of the rupee would stimulate exports and increase export realization.
Vegetable oil imports reached USD 1.89 billion in August 2022, up 41.55 percent from the same month the previous year. According to the SBI study, no central bank can now stop currency depreciation. Thus, the RBI may permit the rupee to decline for a little time. Since the Ukraine War, the RBI’s foreign currency holdings have decreased by USD 75 billion in order to preserve the rupee, it said, adding that this has resulted in a lower import cover of nine months, which is on the low end.
Given India’s solid fundamentals, the study stated, “This is also true that if the currency settles at a lower level, appreciation of the currency goes up at a spectacular rate that is a distinct possibility.” More so than our internal economic fundamentals, a strong dollar is to blame for much of the rupee’s decline, the report added.
According to Madan Sabnavis, Chief Economist, Bank of Baroda, the Monetary Policy Committee (MPC) of the RBI would have a particular issue to address when it meets the next week to review monetary policy. According to the reaction to the dollar’s strength on the international market, the rupee has recently depreciated, making it one of the more unpleasant currencies, he added.
The currency component of the tale “cannot be left out when deciding on interest rates,” he added. “This item will also be actively considered in the debates.” In response to a higher dollar index and risk-off sentiments, the Indian rupee had its worst weekly fall since April 2021, according to Dilip Parmar, a Research Analyst at HDFC Securities.
As the dollar reached a new two-decade high and therefore drove the rupee to a record low level, Parmar continued, “it seems there is no turning back for the dollar.” The Reserve Bank of India Act established the Monetary Policy Committee, which will have its 38th meeting from September 28 to 30.
Due to risk-off investors and a strong US dollar outside, the rupee fell 30 paise against the US dollar on Friday, hitting a new lifetime low of 81.09. At the interbank foreign exchange market, the local currency dropped to 81.23 versus the US dollar, breaking through 81 for the first time ever. It ultimately shut off at 81.09.
Why is the rupee depreciating?
Since the beginning of the year, the rupee has lost about 6.5% of its value. The decline is mostly attributable to increased crude oil prices, a strong foreign currency, and foreign capital outflows. Investors are fleeing risky Indian assets in favour of safe greenbacks as a result of a stronger dollar and dim local development expectations. With the US Federal Reserve tightening monetary policy more than peers, the US dollar has been rising as investors from across the world rushed into the safe-haven currency. Global market risk aversion has caused money to start returning to the US.
This year, the dollar index, which measures the value of the dollar against a basket of international currencies, has increased by nearly 9%, reaching its highest level in 20 years. The rupee depreciates when money leaves India, and the rupee-dollar exchange rates are affected.
Rising imported inflation is the consequence of pressure from a declining rupee on already high import costs for petroleum and raw commodities.
The expanding trade imbalance, which is being caused by imports rising faster than exports, is the main factor contributing to the rupee’s decline versus the dollar. The steep rise in crude oil prices during the Ukraine conflict is mostly to blame for the surge in imports. The import expense has gotten out of hand due to the rising cost of coal and other basic goods, notably raw materials. These imports will be more expensive due to a falling rupee, which will have a short-term detrimental impact on domestic output and GDP. Given that India imports more than 80% of its crude oil, inflation is the main effect of the rupee’s decline.
When compared to the currencies of other nations, depreciation lowers the worth of a nation’s currency. Imports are discouraged by depreciation since the price of imported items rises as a result of the rupee’s decline in value. Inflation increases when commodities get more and more expensive.
The Indian central bank stated in its April monetary policy report that it expects the rupee to trade at roughly 76 to the dollar during FY23, adding that a 5% depreciation from this would result in an increase in inflation of 20 basis points. The rupee has already lost almost 2% value since this assumption, indicating future inflation would be greater.
The pass through of imported inflation rises as a result of the depreciation of the rupee. Additionally, when global crude prices reach historic highs, this will contribute to domestic retail inflation by driving up the cost of gasoline and diesel, which will ultimately raise the cost of products. Additionally, if the prices of commodities throughout the world continue to be persistently high, our import bill will also be high, which would put additional pressure on the cost of basic products.
According to rating agency Crisil, CPI inflation would typically increase to 6.8% this fiscal year from 5.5% the year before. This would be beyond the RBI’s goal range of 2-6% and the highest level in nine years. India relies on imported commodities for its needs because it is a net importer. Since they are imported and purchased using US dollars, the landed price increases and “imported inflation” results. Fossil fuels make up two-thirds of all of our imports. “Multiplier commodities”
Their price increase amplifies the price inflation of food, housing, and clothes. The ramifications for businesses and the government are that servicing and redeeming foreign debt in US dollars will become more expensive (repay). Due to India’s reliance on crude oil imports, fuel prices, which are currently high for cooking gas, diesel, and petrol, it will continue to rise.
Your everyday use of home goods will be indirectly impacted by growing transportation prices. Due to rising production and transportation expenses associated with oil, their prices will rise. The cost of electronics is expected to be high. You will pay extra for items like mobile phones, computers, TVs, and solar plates, among other household electrical goods, because many of their components are imported.
Exporters benefit whenever the value of the rupee falls against the dollar (exporters of software, consumer goods, etc.), since their exports become more profitable as a result of getting more rupees in exchange for the dollar. However, importers suffer since they must pay more to purchase the same quantity that they did before the rupee started to decline. For instance, when the rupee depreciates, industries like oil and gas, food and beverage production, other industries that import raw materials, or capital-intensive industries suffer the most.
In other words, industries that are tied to exports, like the pharmaceutical and IT sectors, profit from depreciation, but those that are linked to imports must suffer increased input costs, which are then passed on to the final consumers. Additionally, as petroleum is India’s main import, any increase in oil prices has a knock-on impact on the price of commodities where transportation is a significant cost factor.
The majority of India’s major exports, including gems and jewellery, petroleum products, cars, and machinery, are imported. Due to increased commodity prices brought on by a lack of supply, exporters’ margins have been impacted by rising production costs.
The weakening currency suggests that new capital investments in infrastructure industries like solar and wind energy, which rely heavily on imported equipment, may suffer. This will result in increased costs, project delays, and decreased capital creation, all of which will lower the economy’s ability for medium-term development.
The inability of manufacturing firms to acquire the equipment and raw materials needed for production in India forces them to rely on other countries, including the US, which increases the demand for USD. India’s limited supply chain is the common denominator in this situation. But the resources of India will quickly be taxed if they are to be able to match the number of imports. Right now, it appears as trade imbalances will never end.
Depreciating the rupee will increase the current account deficit (CAD), which is a trade statistic where a country’s imports of goods and services exceed its exports. This is because India imports more than 80% of its oil needs. In the absence of dollar inflows from foreign investors, India must use its foreign currency reserves to cover this shortfall as the CAD expands.
The Indian Rupee’s decline may also have an effect for people who want to travel or study abroad. Due to higher college fees, higher housing costs, and other living expenditures due to the weakening rupee, as well as higher overseas travel costs, higher shopping costs, and other expenses, one would need to revise their budget numbers.
“The increased costs are non-negotiable and hence cannot be avoided for essential expenses like an international school or medical travel. However, if the costs are discretionary in nature, such as an upcoming family vacation, you may decide to put the planning on hold for around a quarter and see whether the USD cools off “Azuke Personal Finance Advisory’s creator and wellness coach Chaitali Dutta made this statement.
The LRS (Liberalized Remittance Scheme), which permits a person to transfer up to USD 250,000 or its equivalent each financial year, would apply to the remittances to the self-investment account. This advance preparation will guarantee USD price averaging and provide you with the chance to geographically diversify your assets.
Remittances that Indians receive from overseas will increase in value. Therefore, if an NRI sends you money from outside, YOU will receive more money in terms of Indian rupees.
Edited by Prakriti Arora