The rupee has had a rough year so far. It is already at its lowest level against the dollar since December 2006.
And things could get worse from here. Bloomberg says in a report that the Indian currency has had its worst year since 1991.
All this is a far cry from the situation we saw in 2007, when torrential capital flows pushed it up against other major currencies.
But much has changed since then. The current account deficit has widened because of high global oil prices. The capital inflows that are needed to fund this external deficit have dried up; foreign investors have already pulled out around $7.5 billion from the Indian stock market.
A sharp fall in the rupee in the months ahead will need smart responses from both the central bank and companies. The Reserve Bank of India (RBI) has often said that it does not want to guide the rupee to any particular level; its only concern is to dampen volatility in the foreign exchange market. Either way, the fact is that RBI has already used billions of dollars to buy rupees from the market. The official foreign exchange reserves have fallen by close to $21 billion since May.
India still has a large foreign exchange stash. But a weak currency, growing foreign debt, anaemic capital inflows and a wider current account deficit could put further pressure on the hoard maintained by the central bank.
Companies, too, will have to be careful. The weakening rupee is good news for exporters, who will find it easier to compete in a world economy that is slowing. However, others have reason to worry. For example, those companies that have large dollar borrowings will be hit, as they will need more rupees to pay back the dollars they borrowed during the global credit boom of 2006 and 2007. The rupee is not headed into a crisis — as yet. However, there is enough reason to believe that there are testing times ahead for the Indian currency.
That will be one more item on a growing list of economic worries for both the government and RBI — high inflation, slowing growth and a fiscal deficit that, if correctly defined, is at dangerous levels.
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