Economists say external and internal factors to blame for rupee fall

On Thursday, the rupee closed at a 39-month low of 68.73 against the dollar, within striking distance of its record low of August 2013 when it closed at 68.83. 

In intra-day trading though it breached that level, dropping to as low as 68.86. But it is possible that intervention by the Reserve Bank of India (RBI) may have propped it up marginally from its record low. 

Economists, though, are divided on whether this rather sudden slide in the rupee has more to do with internal factors or external factors. 

“The recent decline in the rupee is largely driven by the strengthening of the dollar which has gained against almost all major currencies,” said Madan Sabnavis, chief economist at CARE. 

Aditi Nayar, senior economist at ICRA concurred. “The recent weakening of the rupee is primarily a consequence of external factors. The extent of depreciation displayed by the rupee is in the middle of the pack compared to the currencies of other emerging economies. To some extent, the FCNR (foreign currency non-resident) deposit redemption and the recent demonetisation policy by the government may have contributed to this decline,” she said.

Since the US election results, the US dollar has strengthened against almost all major currencies. Among the emerging market currencies, the worst hit has been the Mexican peso which has declined 13% against the dollar since November 8. The Turkish lira has fallen by eight%, while the Brazilian real and the South African rand are down seven and 7.2% respectively. 

Developed countries, too, have seen their currencies fall against the dollar. The euro is down 4.3%, while the Japanese yen is down 7.5%. The pound, though, is marginally up. 

The trend appears secular. According to a study by CARE, 11 currencies which had appreciated against the dollar prior to November 8, depreciated sharply thereafter. But what is interesting to note, as the report points out, is that the “rupee has not performed too unsatisfactorily as it is at the median change in this set of countries at 2.64%”. The study looks at currency movements till November 18.

It is likely that the strengthening of the dollar reflects the changing perception about the US economy under President-elect Donald Trump. 

Economists contend that higher fiscal spending by the US government, as promised by Trump in the run-up to the elections, coupled with lower tax rates, would not only stimulate the US economy but may also prove to be inflationary. This would put pressure on the US Federal Reserve to raise rates faster than what was anticipated before. Higher interest rates in the US are likely to strengthen the dollar as investment flows back to the US from other economies, especially emerging ones.

But other economists disagree with this prognosis. Soumya Kanti Ghosh, group chief economic advisor at the State Bank of India, said, “Part of the rupee’s recent weakness is because of the FCNR redemption. It (rupee’s weakness) seems to be driven by domestic factors. I’m not sure how much it is driven by external factors.”

Ghosh’s view is based on the fact that during the period of global uncertainty, the rupee was rather steady. Sound macroeconomic fundamentals — a declining fiscal deficit and current account deficit and moderating inflation — were then cited as the reason for the rupee’s steady performance. 

It is also possible that other internal factors may well have played their part. “There is also some urgency being shown by importers to book their dollars before the month-end which has increased demand for dollars,” Sabnavis said. 

Though economists expect the volatility to continue till there is greater clarity about Trump’s economic strategy, Pronab Sen, former chairman, National Statistical Commission raised an interesting point. “The real question is what will happen when people start creating black money. Will they decide to keep their cash holding in rupees or will they prefer to switch to the dollar,” he asked.