How a weaker rupee will impact the Indian economy and people?

For the first time, the Indian rupee breached the psychological barrier of 77 against the dollar on Monday to close at a record low of 77.46, raising fears that India’s inflation situation could worsen. 

Retail inflation in March neared the 7% mark, largely reflecting the impact of geopolitical spill overs and a Reuters poll suggested that it likely surged to an 18-month high of 7.5% in April.

Widening trade and current account deficits, heavy foreign fund outflows and a strengthening US dollar have pulled the currency down nearly 4% this year. 

The trade deficit surged over 30% year-on-year to $20 billion in April, mainly on the back of higher energy prices. 

India’s current account deficit is expected to widen from 1.5% of GDP in FY22 to as much as 3%.

Meanwhile, foreign investors have pulled out a whopping $19 billion from the Indian markets in this calendar year so far. This compares to net inflows of $7 billion in 2021, $14 billion in 2020 and $19 billion in 2019. 

The US dollar has been on a tear as investors piled on the safe-haven currency with the Federal Reserve seen as tightening monetary policy more than peers. Risk aversion in global markets means funds are flowing to the US.

The dollar index, which tracks the currency against a basket of major currencies, is up nearly 9% this year and hit its highest in 20 years. 

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It is not just the rupee but most currencies were sent tumbling because of the dollar upcycle. In fact, the Indian rupee has performed relatively better than some of its emerging market peers.  

Speaking to Business Standard, Rahul Bajoria, Chief Economist, India and the Antipodes, Barclays Investment Bank said rupee is not being singled out in terms of weakness. Chinese yuan, Korean won and Japanese yen fell more than rupee in last 3-4 months, he said adding that several Asian currencies have weakened across the board.

The biggest impact of a weakening rupee is on inflation, given India imports more than 80% of its crude oil, which is India’s biggest import.

Oil has been hovering around $100 a barrel for more than two months now and a weaker rupee will add to inflationary pressures. India is also heavily dependent on other countries for fertilizers and edible oils. The country’s fertilizer subsidy bill is already set to hit a record high of as much as Rs 1.9 trillion this fiscal, according to Crisil. 

While a weak rupee makes imports costlier, it has some benefits too. It makes our exporters more competitive in theory.

But in a scenario of weak global demand and lingering volatility, exporters are not cheering the currency dip.

Ajai Sahai, director general of the Federation of Indian Export Organisations, recently told Business Standard that India may not gain much if a competitor’s currency is depreciating at a faster pace. 

Further, India’s key export items such as gems and jewellery, petroleum products, organic chemicals and automobiles, and machinery items have a significantly high import content. With rising commodity prices due to supply shortages, the cost of production for exporters will go up, affecting their margins.

Therefore, export sectors where the import intensity is high such as electronics, may not see a gain. Services sectors like IT and labour-intensive export sectors like textiles will indeed benefit.

Barclays Investment Bank's Bajoria believes the biggest impact of weakening rupee will be felt on inflation side. He says, export earnings may improve but it will only be a mitigating factor. Rupee has held up reasonably well against peer currencies and we have enough reserves to meet any contingencies, he says. Price effect is more dominating than exchange rate effect, he says.

India’s foreign exchange reserves have fallen below $600 billion for the first time in a year as the RBI intervened in the forex market to defend the rupee. The reserves fell to $597.7 billion for the week ended April 29, down from the all-time high of $642 billion at the beginning of September last year. Most of this fall has come in the last two months.

Rahul Bajoria says that over the next 3-6 months rupee could weaken further beyond 78 level and go as low as 78.50 or even 79 levels.  

However, he says that in the second half of the fiscal year, with the RBI expected to play catch up with the US Federal Reserve on the interest rate cycle, rupee may stabilise with marginal appreciating bias. Nevertheless, experts are of the view that India has enough firepower to stem any sharp slide in the local currency.