Will the rupee fall further?

June 3, 2013

(Any opinions expressed here are those of the author and not of Thomson Reuters)

On May 31, the rupee fell to an 11-month low of 56.51 to the dollar. It wasn’t the only currency to suffer a loss. Most currencies depreciated during the month; some more than the others.

The appreciation of the dollar reflects an improvement in the performance of the U.S. economy and partly the related possibility of the phasing out of quantitative easing (QE) by the U.S. Federal Reserve. The latter would make the dollar even scarcer.

The rupee and the yen lost the most. The behaviour of these currencies in May was rather unusual and trends are different if seen over a longer period. In the past year, for instance, the yen fell 27 percent because of its planned weakening by the Shinzo Abe government to boost an economy bordering on recession. But a number of other currencies in emerging market economies such as South Korea, Thailand or Malaysia appreciated largely because of hot money inflows from quantitative easing. Some of these countries have or are likely to adopt capital controls. Brazil’s finance minister called it the ‘currency war’.

India has a different story to tell. The rupee has been weakening because of internal depreciation caused by high-paced inflation. From 45 to the dollar, it lost 25 percent in about 25 months.

In the short term, the exchange rate depends like any other commodity on demand and supply of dollars in the market. The net demand is measured by the current account deficit and the net supply by capital inflows subject to changes in reserves by the Reserve Bank of India used mainly to even out sharp fluctuations. In the quarter ending December, the current account deficit was 6.7 percent of the GDP. The rupee fall in the month of May was possibly due to appreciation of the dollar against all major currencies and also due to the current account deficit that may have been inflated by excessive gold imports.

How will the rupee behave in the next three months? It looks like exports will not pick up, oil imports will increase due to consumption demand rather than price, gold imports will taper off and other imports will increase marginally. Neither will there be much improvement in invisibles. As such, the current account deficit may be around 4.5 percent.

Whether the rupee will fall further or bounce back will depend largely on FII investment. In the first five months of 2013, FIIs invested $15 billion. They can continue to invest if quantitative easing by the U.S. Federal Reserve is not stopped and our stock market remains bullish. There are no triggers in view which can kick up the market except reforms that the government assures from time to time. In the absence of positive action, the rupee may find a new saddle point which may be 56-57 to the dollar.

No comments so far

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/