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What you should know about the weak rupee
The Indian rupee hit its lowest in 2013 recently. It fell 3% in May 2013 and the trend is expected to continue. This is despite strong foreign fund flows.
Here’s why the currency is under pressure:
Strengthening Dollar: The US dollar strengthened globally in anticipation of an end to the loose monetary policy of the US Federal Reserve, the US central bank. It had said that it would continue to print money as long as needed to stimulate growth in the US. If the US stops this programme, it would mean demand for the US dollars would remain high but supply would slow down. Most emerging economy currencies weakened. In India, a factor that influenced the strong US dollar was also the demand from oil importers. “Participants were overly short on the US Dollar. All in all, it was the market which was vulnerable to a short squeeze,” said a Kotak Securities report.
Widening current account deficit (CAD): The rupee fall comes despite strong foreign flows into stocks and debt markets this year. Finance minister P Chidambaram continues to be on road shows overseas ever since he presented the Union budget selling the India story to foreign institutional investors. Worsening trade deficit is bad news for the rupee as the demand for US dollars goes up.
April and May are seasonally the worst months for the country’s trade deficit. Sectors such as fertilizers, chemicals and oil see a seasonal pickup in imports ahead of the sowing season. The current account deficit, which is the difference between the outflow and inflow of foreign currency, touched a record high of 6.7% in the December quarter of FY13 on the back of rising oil prices and imports. A higher current account deficit weakens the currency.
RBI dollar-buying: The Reserve Bank of India (RBI) is back in the foreign exchange market and bought $820 million in March to shore up reserves, according to its latest bulletin. RBI intervened significantly since 2008 to buoy the Indian rupee by selling foreign exchange. India’s imports are rising and exports are slow. This means if India were to use foreign exchange reserves to pay for imports, it would be possible to do so only for 7 months. This is the lowest level since 1997, according to one media report.
Outlook The outlook is mixed as a fall in gold prices along with tightening of rules may mean a marginal slowdown in its imports. However, very few analysts expect a sharp rally in the rupee. The dollar buying by Reserve Bank of India, finance minister’s trips overseas for foreign inflows, weak exports and strengthening of US dollar against major global currencies point to a weakness in the rupee going forward.
A key factor hurting the value of the rupee is the continuous surge in gold imports. India imported gold worth $ 7.5bn in April 2013. This was a sharp jump from $3.1bn in March 2013. To put this number in perspective, India’s trade deficit, the excess of imports over exports, stood at $17.8bn in April 2013 against $ 10.3bn in March 2013, according to the government data. To keep up with the demand for US dollars, India needs more foreign inflows in the form of capital flows and foreign direct investment. Strong FII inflows in equity and debt market along with foreign direct investment could help.