Doomsday scenario? Rupee to haunt RBI, economy, govt, if not saved from free fall

A new trend has taken place in India, and this time it is the shocking free fall of the domestic currency against US benchmark dollar index, which is shining to an extreme, making things even more difficult for the NDA government in coming days. This year, the Indian rupee depreciated by 13% in 2018 highest ever because it is trading now at an all-time low of over Rs 72 against the dollar. The highest free fall in rupee has been witnessed since June 2018 by 7% alone when RBI started hiking policy repo rate. While the government is trying to stay calm over this uproar in USD/INR pair, however, many analysts have started to estimate even more weakness in rupee, which can create difficulties for Indian economy going ahead. 

Today, the Indian rupee is trading at 71.855 down by 0.13% against the US dollar, however, since the start of trading session, it has touched a low of 72.015. 

Anindya Banerjee, analysts at Kotak Securities on today’s trading session said, “One more new life time high in Dollar Rupee, this time at 72.10 on spot. It's been a brutal week for the Rupee. One can blame EM currency turmoil or higher oil prices for Rupee's woes but this week Rupee remains one of the weakest in the basket.”

Banerjee added, “Technically, USD/INR remains within a primary uptrend. Unless prices are closing below 69.00, any sharp correction, 1-1.5%, is an opportunity to enter fresh longs on USD and short on INR. However, over the near term, a corrective dip cannot be ruled out.”

Weak rupee is not a good sign for Indian economy, because it adds inflationary pressure as imports become costlier and therefore increasing the prices of key commodities such as oil, imported coal, minerals, and metals. Going ahead, oil accounts 70% of import in India and with rupee in free fall this will even impact India’s Current Account Deficit (CAD) which is not a good sign for NDA government. 

However, Finance Minister Arun Jaitley blames the weakness in rupee on global factors and has shown calmness towards the current trend. But it is being expected that rupee will continue to face pressure ahead. 

Jaitley stated that, the fall in rupee to global factors and said there was no need for panic or knee-jerk reactions. 

Interestingly, Dr. Soumya Kanti Ghosh, Group Chief Economic Adviser at State Bank of India said, “In the offshore NDF markets the rupee is trading at Rs75 per dollar levels. During this financial year the rupee has depreciated sharply; with NDF implied yield on rupee hardening sharply from 6.5% to 7.7% in September. The last 364 day T-bill cutoff was 7.32%. Thus, rupee will continue to face pressure in foreseeable future.”

Ghosh adds, “We analysed the movement of rupee against dollar since global financial crisis period and it is quite visible from the data that depreciation was always followed by appreciation of currency. There were two instances where, the phase of currency depreciation lengthened more than 3 quarters, but once the currency settled at a lower level, appreciation of currency picked up dramatic pace.”

Therefore, Ghosh explains by any stretch of imagination, the depreciation in rupee has now outpaced other Asian currencies like Indonesia. He believes, beyond a certain level of depreciation, the costs could outweigh benefits. There are many components of such cost. 

Short-term external debt repayment

As on December 2017, India’s short term debt obligations stood to the tune of $217.6 billion. Assuming half of this amount has either been paid in H1 2018 or is rolled over to 2019, the remaining repayment amount in Rupee terms would be Rs 7.1 trillion at average 2017 exchange rate of Rs 65.1/ US dollar). 

For H2 assuming that rupee depreciates to an average value of 71.4/US dollar, the debt repayment amount would be Rs 7.8 trillion, thereby implying an extra cost of Rs 670 bn. This is a model estimate of the cost that depreciation can put on the country as the repayment is done throughout the year. 

Oil import bill

Next is the impact on oil import bill. SBI assumes that the volume of our crude oil imports would increase by a modest 3.6% (average of past 5 years) in 2018.

With rupee depreciating to an average of Rs 71.4/US dollar in H2 2018 end, the import bill would increase to Rs 4036 billion, implying an extra cost of around Rs 0.353 trillion. With crude oil averaging to $76/bbl for the remaining half and average exchange rate at Rs 73/ US dollar the extra cost could go up to Rs 457 billion.

Inflation

As per RBI, a depreciation of the Indian rupee by around 5% relative to the baseline, inflation could edge higher by around 20 bps. 

With rupee expected to depreciate by say around 14% this year, keeping everything else constant inflation could edge by 56 bps going by the RBI numbers. 

Consumption

If the rupee continues to depreciate, it may move RBI towards increasing the regulatory interest rates. This could pressurise RBI to go for more rate hikes. RBI’s successive rate hikes will have a negative impact on consumption expenditure (PFCE) as well as investment expenditure, thereby widening the output gap. 

During Q1 FY19, PFCE increased by 8.6% (6-quarter high) and RBI has already hiked Repo rate in two successive rate hikes. The continued rupee depreciation and given the significant costs of RBI intervention in forex market and hence the RBI apathy to take that route could result in at least one more hike, possibly frontloaded. 

Now, this may have impact on PFCE in Q2 FY19. If we mimic the trend that was followed in FY15 we may expect PFCE to decline in subsequent quarters and this may lead to Rs 500 billion decline in consumption expenditure. 

Fiscal Cost

With yields crossing 8%, there will be increased fiscal costs on the part of the Government every year. 

SBI says, “We expect such costs to be at least Rs 6000-7000 crores. Interestingly every year, Government generally frontloads the borrowing programme to the H1.”

State Government’s borrowing trend is similar to Central Govt. This was mainly to avoid the rising interest costs to the Government. However, as a result, there will now be increased borrowing pressures on the Government and hence yields will increase from current levels. 

From the above it is clear, a solution is needed by RBI in order to calm down the Indian rupee, however, the tables have turned. Even RBI intervention in rupee has its own pros and cons. One aspect can be hike policy repo rate but that will turn against the banking sector which is already in cash shortage and trapped with stressed assets. Therefore, how RBI and rupee go ahead will be keenly watched.