Mint Explainer: Why the risk of further rupee depreciation may be overblown

In 2022, the rupee saw an 11% slide, plunging from ₹74.21 to ₹82.61 by year's end – the most significant drop since 2013. Market experts estimated that the Reserve Bank of India (RBI) drew nearly $100 billion from its reserves to bolster the rupee.

Comparable currencies faced similar, if not worse, devaluations. After plummeting to a low of ₹83.18 per dollar in October last year, the rupee had rebounded to ₹82.30 by July 2023. The RBI's believes that the rupee's current valuation is consistent with its long-term trajectory.

The steep fall in 2022 was largely attributed to global incidents: the ongoing Russia-Ukraine conflict, successive interest rate hikes initiated by a bullish U.S. Federal Reserve, and the subsequent ripple effect on other central banks. Furthermore, escalating crude oil prices and halted supply chains as economies scaled back on trade openness further destabilized the currency. Add to this mix, the smorgasbord of geopolitical crises across several countries.

But latest economic data prints and government estimates indicate that India’s economy is strong and resilient. So the underlying question is: what’s the cause for concern?

What might lead to the rupee's further depreciation?

Crude oil prices in global markets have surged from $78.35 at the end of 2022 to nearly $93.70 as on 16 September. Market experts expect prices to hit $100 due to supply cuts announced by prominent producers like Saudi Arabia and Russia.

Earlier, there were expectations that the US dollar would weaken, which meant the rupee and other currencies would strengthen. The dollar has gotten stronger, and the US economy continues to exhibit great strength, so the risk of the rupee’s depreciation goes up.

Globally, inflation remains a persistent problem, and central banks have made fighting it their number one priority. There may be high short-term costs in raising interest rates to their highest levels in recent times, but central bankers are determined that inflation is their biggest enemy. Persistent global inflation can be imported, leading to some weakening of the currency.

Market predictions lean towards a 2-2.5% depreciation, suggesting an exchange rate of ₹83.5 to ₹84 against the dollar

How will it affect the stock market?

At the beginning of the year, market analysts had estimated a certain amount of foreign direct investment (FDI), approximately $35 billion for the year. There has been a slowdown in private investment and FDI globally, so that amount may not be achieved. The effect will be felt in some degree through the equity markets.

The strengthening of the US dollar has also resulted in a firming of interest rate differentials in favour of the US, which unlike the rest of the world is not affected badly by rising oil prices. The favourability of interest rate differentials is felt in the yields in the bond market which continue to rise everywhere else.

The change in expectations, both on FDI flows and the dollar remaining strong, will likely end up being expressed in the depreciation of the rupee, though not a very large one, as shown previously.

How will it affect the economy?

One evident impact will be on the current account. In recent months, there has been a slowdown in exports, with government curbs on overseas sales of agricultural goods. There has also been a decrease in imports, as is visible from the constraints imposed on the import of computers and personal electronics.

Services exports have been affected by the decline in IT/ITES exports, but that been offset by the increase in other services exports, like management and consulting services, which grew and stabilised in the post-Covid period..

Overall, the maximum projected current account deficit might touch 1.4% of the GDP – a manageable rate without a pronounced effect on the exchange rate.

The writer is a freelance journalist.