The rupee has suddenly reversed course. It was not too long ago when the rise of the rupee against the dollar had policymakers worried and exporters crying blue murder. And now this. The rupee has dropped more than 6% against the US currency since mid-April. It is cheaper than what it was a year ago.
Three factors are at play. First, the bounce in the US dollar as the Fed seems to be coming to the end of its rate-cutting spree. Second, foreign portfolio investors have been selling Indian equities; their net sales this year are close to $2.8 billion. Third, the sharp rise in global oil prices has increased India’s import bill and widened its trade deficit.
All three factors are important. But the third is of special concern. The rise in oil prices has pushed up the current account deficit to levels that are worrisome, though not yet dangerous and unsustainable. India right now has ample capital inflows to finance this widening external deficit and huge foreign exchange reserves as insurance against a sudden outflow of capital. But large current account deficits can be a macroeconomic risk when the global markets are unsettled.
Given the constellation of economic factors right now, we expect the rupee to remain weak against the dollar in the medium term.
The sudden drop in the rupee will take some pressure off the government from the vocal exporters’ lobby. But two new concerns will emerge. One, a weak rupee will raise import prices and feed the inflation fire. Two, Indian companies with large foreign exchange liabilities could take a hard knock.
In itself, the rise and fall in the rupee should not be a worry. It’s just a price, and will bounce around like all other prices. The deeper problem is how companies and consumers respond to the changes in the rupee’s value and how they manage the attendant risks.
The recent gyrations in the currency have caught companies by surprise. They will have to learn to be more careful with how they handle the dollar and other currencies. The regulators should accept that despite all the recent problems with cross-currency options, Indian companies need a vibrant derivatives market to handle currency risks.
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