lipped from: https://www.financialexpress.com/opinion/no-cause-for-panic-rupee-fall-is-a-concern-but-it-is-still-over-valued-in-terms-of-reer/2519535/
The rupee’s fortunes can look up if capital flows are strong. It is possible FPIs will come back to the equity market once valuations turn more attractive
The central bank is estimated to have sold around $45 billion since November.
The rupee has held up surprisingly well and remains a relative outperformer among its emerging market peers, even though crude oil prices have risen sharply since the beginning of the Russia-Ukraine hostilities and foreign portfolio investors (FPI) have pulled out around $25 billion since last November. In fact, between November and late February, the currency barely moved. Even after the escalation of geopolitical tensions, the downtrend had been relatively modest. The relative strength of the Indian currency has been attributed to intervention in the currency markets by the Reserve Bank of India (RBI), which has used some of its $600 billion-plus to good use. The central bank is estimated to have sold around $45 billion since November.
But there is no doubt that the rupee has now started feeling the pressure, with the US Federal Reserve kicking off its rate hikes last week, the dollex (DXY) strengthening, and crude oil prices expected to stay elevated in the foreseeable future. On Monday, the rupee fell to a lifetime low of 77.47 against the dollar (it recovered 12 paise on Tuesday). There is a broad consensus now that India’s current account deficit could widen to 3-3.5% of GDP or more this fiscal, depending on where oil prices rule. That would push the balance of payments into a deficit from a surplus. Costlier imports might help rein in demand for some products, but the import bill is expected to be high unless prices of crude oil, coal, fertiliser and edible oil correct meaningfully. When the rupee depreciates, it also directly impacts inflation as India still imports over 85% of its oil requirements. The government must therefore keep a close watch on the import bill and, if possible, rein in imports of at least some items without disrupting manufacturing. Experts believe a trade deficit of over $300 billion would be a concern.
Unfortunately, the factors that have worked to drive up the dollar are unlikely to fade away anytime soon. There is little clarity on the turn the geopolitical situation could take, how long the Russia-Ukraine hostilities would last and the resultant quantum of Russia’s supplies to the oil market. Crude-prices forecasts for 2023 range from an average of $100-120. Under the circumstances, the dollar is likely to be a safe-haven currency, at least until inflation is tamed and the US Fed is done with most of its rate hikes. As of now, the markets are pencilling in rate hikes of around 250 basis points. As such, the dollar is expected to stay strong and would start reversing its trajectory only when the US economy slows significantly. While interest rates will rise in India too, the increase will be less than that in the US, keeping the rupee under pressure.
The rupee’s fortunes can look up if capital flows are strong. It is possible FPIs will come back to the equity market once valuations turn more attractive. Foreign direct investment (FDI) has been more stable and should continue to flow in at an annual level of a net $40 billion. Exports have been doing exceptionally well, but the slowdown in global growth and global trade could see some loss of momentum. The point to note is that even after the fall on Monday, the rupee remains over-valued in terms of the Real Effective Exchange Rate (REER). While it is true that a weaker rupee doesn’t give exporters a very big edge as they typically are price takers, over-valuation doesn’t help either. What the government can do is to upgrade infrastructure to make it easier for exporting units to operate more efficiently. Services exports are doing exceptionally well and should continue to do so. The recent fall in the rupee, therefore, should not be cause for a panic. Indeed, it would appear that RBI is comfortable with these levels.