The strong rupee’s dividends are waning, costs are rising
The Indian currency has had a stellar run in 2017 and could very well continue with the performance for one more quarter if forecasts are to be believed. The median forecast of a Bloomberg survey of 50 respondents puts the rupee at 64.8 to a dollar in the next three months, a mild depreciation. The offshore non-deliverable forward market also indicates the currency will be trading around 64 to a dollar.
It is clear that a strong rupee has been a big boon for a net importing country like India. The country’s import bill has hardly swelled despite the recent rise in global crude oil prices as an appreciating currency has offset the impact to some extent. The result has been a very manageable current account deficit (CAD). CAD is expected to be around 1.5% of gross domestic product for fiscal year 2018. That is the lowest in four years.
Another pleasant effect has been that an appreciating rupee has offset the effect of rising global crude oil prices on domestic inflation. Indeed, retail inflation has remained largely below the Reserve Bank of India’s (RBI’s) target of 4% for most of 2017 mainly because of subdued fuel inflation.
But this benefit is thinning out as crude oil prices continue their march upwards. After all, a mild appreciation in the exchange rate can hardly dent the effects of a surge in global commodity prices. Already, forecasts of crude oil reaching $100 a barrel are being aired.
As benefits shrink, the costs are rising.
A strong rupee makes all kinds of imports attractive and hurts domestic manufacturing. Manufacturing imports (excluding oil, gold and silver) have surged and domestic industrial output and investment remains subdued. Such imports grew 23% in November.
Another cost is fiscal. The central bank has had to mop up as much as $22 billion from the foreign exchange market between January and November 2017. That means RBI had to sterilize the liquidity this operation injected through issuing bonds.
The central bank abhors volatility and since its relentless intervention could continue, the fiscal cost would only rise.
What the RBI intervention also does is make companies comfortable enough to keep their forex positions unhedged, which is another risk.
A strong rupee may be appealing for everyone but it is time to focus more on what it is costing the economy.