Home > Markets > Mark To Market > Does the rupee's decline open the door for imported inflation?
(Photo: Reuters)
(Photo: Reuters)

Does the rupee's decline open the door for imported inflation?

  • The domestic currency has depreciated around 2.72% so far this year and nearly 3.65% in August
  • Imported inflation calculated using the wholesale price index components was in negative territory in July

Mumbai: The Indian rupee breached the 72-a-dollar mark last week, hit by the double whammy of weak local and global economic indicators, though it has since recovered a bit. The weakening of the domestic currency in the past two months has renewed concerns of a return of imported inflation.

When the general price level rises in a country due to the rise in prices of imported commodities, inflation is termed imported. Inflation may also rise due to depreciation of the domestic currency, which pushes up the landed rupee cost of imported items.

“As we are a net importer, the concern is palpable. If the rupee depreciation is sustained, there will be an impact on inflation," said Madan Sabnavis, chief economist at CARE Ratings Ltd. “With the currency moving from levels of 68-69 per dollar in March to 72 per dollar now, the 5% increase will work through the fuel component for sure. Historically, imported inflation has worked its way decisively through the fuel component. Any sustained increase in oil prices past the $65-per-barrel mark can be a concern."

Currency analysts foresee the rupee to be range-bound around 71-73 per dollar in the near term. However, limited fiscal space to fix anaemic domestic demand raises downside risks to this forecast. The rupee is among the worst performing Asian currencies and has depreciated around 2.72% this year. In August, it weakened nearly 3.65%.

“Growing risk aversion amongst investors in recent weeks has resulted in broad losses in EM (emerging market) currencies, but the rupee has been further impacted by escalating tensions in Kashmir and a slightly larger-than-expected rate cut from the RBI," said a 21 August report by London-based research firm Capital Economics. “Looking ahead, we are forecasting a further drop in the rupee. For a start, we think that India’s central bank will loosen policy yet again at the next MPC (monetary policy committee) meeting in October. The effect would be compounded if investors think that aggressive policy loosening will lead to higher inflation in the future."

As the chart shows, imported inflation calculated using the wholesale price index components was in negative territory in July.

(Graphic: Paras Jain/Mint)
View Full Image
(Graphic: Paras Jain/Mint)

“Since most of the consumer price index (CPI) basket is weighted to domestic goods with a sizeable portion also weighted to services, the sensitivity of CPI inflation is relatively muted to exchange rate movements," said Suvodeep Rakshit, an economist at Kotak Institutional Equities Ltd. “However, the Reserve Bank of India estimates a 20-basis- point impact on CPI inflation from 5% depreciation in the rupee."

Indranil Pan, chief economist at IDFC First Bank, said imported inflation is not an immediate worry. “Since CPI inflation is muted, any further depreciation in the Indian rupee may not lead to a significant pass-through, thus offsetting the impact of imported inflation. Also, a rise, if any, in imported inflation would mean that input costs for manufacturers increase. But given the subdued demand conditions, it is unlikely that they will pass on any such increase in operating costs to output prices."

Meanwhile, prices of Brent crude, the biggest driver of India’s import bill, are around $60 a barrel, lower than the $65 a barrel threshold Sabnavis said was a pain point. On the other hand, the price of gold, another key contributor to India’s imports, is hovering at $1540 an ounce. In rupee terms, gold prices, at around 39,000 per 10g, are near their all-time highs.

Future movements in the prices of these commodities depend on geopolitical factors. Dull global growth prospects could keep crude prices benign. But more uncertainty could lead to higher safe haven demand for gold, pushing prices higher.

While economists aren’t pressing the panic button on imported inflation yet, a fragile global economy and trade tensions warrant a close watch on this indicator.

“Even though we expect India’s external position to remain manageable (current account deficit below 2%), global risk aversion (trade war uncertainty and slowing global growth) could exacerbate the INR weakness," said a 30 August UBS Evidence Lab Survey.

Subscribe to newsletters
* Enter a valid email
* Thank you for subscribing to our newsletter.

Click here to read the Mint ePaper Livemint.com is now on Telegram. Join Livemint channel in your Telegram and stay updated

My Reads Logout