Bottomless pit

It is becoming hazardous to predict the course of the rupee after the 12 per cent fall in its value against the US dollar since the start of the year. The Cassandras have been reworking their forecasts furiously, especially after the Indian currency hurtled towards the 72 per dollar mark on Wednesday, a level that many felt would be breached in December. 

  • Published 6.09.18
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It is becoming hazardous to predict the course of the rupee after the 12 per cent fall in its value against the US dollar since the start of the year. The Cassandras have been reworking their forecasts furiously, especially after the Indian currency hurtled towards the 72 per dollar mark on Wednesday, a level that many felt would be breached in December. With the Reserve Bank of India's intermittent bouts of intervention proving to be ineffectual and both the Centre and the central bank inclined to let market forces determine the currency's value against the greenback, there appears to be a growing realization that it is futile to whistle against the wind. But the experts have been unable to come up with a credible explanation for the down draft that has walloped the rupee, making it the worst-performing currency in Asia. Why should the currency of the fastest-growing economy in the world fall off the cliff?

All the macroeconomic numbers have looked fairly good. Economic growth is strong even if it is on a low base, retail inflation is under control at 4.17 per cent in July, foreign exchange reserves remain firm at $401.3 billion, and the current account deficit at just below 2 per cent of GDP can easily be papered over by foreign direct investment inflows and workers' remittances. The surge in crude oil prices to around $78 a barrel, the trade spat between the United States of America and China, and the anticipated ripples from looming US sanctions against Iran have caused deep anxieties about the global economy.

Two other factors have started to weigh on emerging market currencies: the fear that there will be huge fund outflows when the US Federal Reserve raises interest rates. The Fed has already raised rates twice this year and is widely expected to pull the trigger two times before December. This will put pressure on the RBI to raise interest rates in tandem. Secondly, all through last year, the RBI wrestled with the problem of surplus liquidity that it was forced to mop up through bond operations. New bond issuances had the effect of raising bond yields, piling pressure on the RBI to raise rates. The market believes that the central bank could raise the policy rate again without waiting for the next monetary policy review in early October. A surge in rates will attract foreign fund flows, which could stabilize the rupee. But it will leave the central bank with the problem of surplus liquidity that it will have to sterilize. The RBI will be hoping to use the untried standing deposit facility, an instrument that will enable it to suck out liquidity without offering any collateral. But that still leaves everyone puzzling over the coffee-table question: what is the exchange rate bottom for the rupee?

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