Is 70 the new 60 for the rupee?
The Indian rupee is on the slide.
This week the currency slipped below the 68 level against the US dollar as global markets went into another tailspin, led lower, mostly, by fear. Some are attributing the turmoil across global markets to plunging oil prices and others to weakening Chinese growth. The bottomline—there is fear in the markets and that’s pushing investors to take money off the table.
Since the start of this year, foreign portfolio investors (FPIs) have sold $1.23 billion in the local equity market.
While FPIs are still net positive in the debt markets, there have been some days of selling there as well.
If this selling pressure from FPIs persists, and it looks like it might until the global mood stabilises, the rupee will likely move down towards its 2013 record low of 68.85 a dollar and perhaps even further towards 70. This is assuming that the Reserve Bank of India (RBI) doesn’t try and step in to prevent a decline to those levels and continues with its level-agnostic intervention strategy. In an interview to Bloomberg News in Davos, RBI governor Raghuram Rajan said that the fair value of rupee is “what it is”, adding that the RBI does not have any rupee target in mind.
At least four forecasters—Barclays Plc., UBS AG, Morgan Stanley, Royal Bank of Scotland Plc—expect the rupee to breach the 70-mark this calendar year. Kotak Mahindra Bank Ltd feels that the rupee may move to 70-72 to a dollar next fiscal, although it may not be their base case scenario.
The move towards 70 a dollar, if and when it happens, will undoubtedly generate dramatic headlines and commentary. Many will question the RBI and the government’s policies. Some will call for measures to stabilise the Indian currency.
They shouldn’t. After all 70 is just another number. Just like 60 was when the rupee first breached that level in June 2013. And the same as 50, when it was breached in November 2008.
There are some strong arguments in favour of a weaker rupee at this stage, even though there will be negative consequences for some sections of the industry and the markets. One clear argument remains the overvaluation of the Indian currency based on the real effective exchange rate (REER) index. The 36-country REER, which benchmarks the domestic currency against its trading partners, was at 113.21 in November and 112.86 in December. A level of 100 (or a little above that) would imply fair valuation for the Indian currency.
This means that even though the rupee has weakened, the depreciation has not been out of sync with other currencies. In other words, the fall has not managed to correct the overvaluation of the Indian currency. Exporters and those who deal with the export sector say the currency has played a role in the continued fall in exports. While it is true that global demand is weak, the overvalued currency has eroded the competitiveness of lower-end exporters and amplified the decline in overseas shipments.
There is also now a strong case to be made to ensure that the rupee does not diverge significantly from the movements in the Chinese yuan. A number of domestic industries are feeling the pain from cheap Chinese imports and if the yuan depreciates much more than the rupee, it would further hurt the competitiveness of domestic manufacturers. So far, the yuan and the rupee have moved in sync. The 5.6% depreciation in the yuan since 10 August has been matched by a 6% fall in the Indian currency.
An added benefit of allowing the rupee to find a natural level at this juncture, is that there is no substantial fear of imported inflation. Oil and commodity prices remain at multi-year lows and so the inflation implications of a weaker rupee, while not entirely absent, are more easily absorbable.
Historically, the rupee has fallen by a compounded annual rate of 3.7% since 1992, according to Bloomberg data. If you stretch that performance to the current year, rupee should move down to about 68.65 a dollar just on the basis of that track record. But if this turns out to be a year of market turmoil and foreign outflows, then a level closer to 70 a dollar isn’t out of the realm of realistic expectation.
And of course, there will be those who get hurt. Foreign equity investors, who haven’t made spectacular gains in India last year, will take another hit because of the falling currency and may choose to lock-in whatever gains they have on the table. But this will only happen if there is an expectation of uncontrolled depreciation, which is not the case currently. The RBI has enough firepower in the form of over $350 billion in reserves to defend the rupee if needed. Medium- and long-term investors will recognise that. Companies who have borrowed abroad will take some hit, too, as repayment obligations will rise in rupee terms.
Those who left foreign currency exposures unhedged will feel some pain. But given the repeated warnings from the RBI to hedge foreign exchange exposures, this constituency does not deserve much sympathy. On balance, a depreciation in the rupee at this stage, if it comes at a measured pace, is not something to fret about. If the rupee touches 70 a dollar in the process, so be it. Let’s just think of 70 as the new 60 and move on.
Ira Dugal is assistant managing editor, Mint.