Starting sometime around April this year, we saw the rupee starting to weaken against the US dollar. This was in line with major currencies and no one gave it much of a thought. But by August, the perceptions began to change when rupee touched the 70 mark versus a dollar. All of a sudden, investors sat up and took note
They suddenly started asking if it is really so bad - a falling rupee? Is it historically the worst fall? Does it hurt the economy and is the impact long term?
Yes the impact can be long term but you will be surprised that it is positive! But let’s first understand why rupee fell or what were the key factors that led to its fall? It’s important to note here that any event that increases outflow or demand for dollars in a country leads to weakening of domestic currency.(1)
- Increase in rates by central bank of USA or Federal Reserve - also called Fed. This resulted in Foreign Institutional Investors(FIIs) withdrawing investment dollars from emerging economies like India. This increased demand for dollars in India.
- Rise in crude oil prices - After years of moderate prices since 2014, crude oil prices started to rise this year due to USA’s sanctions on Iran - a large oil supplier. Crude oil prices had reached over $80 a barrel in September from about $65 at the start of the current year. India is dependent on oil imports for more than 80% of its requirement and pays for it in dollars. Hence increased oil prices led to increased demand for dollars.(5) (7)
- Imports of non-crude oils also increased more than overall exports - This adversely impacted the balance of payments and resulted also in overall trade deficit. Essentially all trade is in dollars. Hence, the deficit means that the difference to be paid out in dollars and this again increased demand for dollars.(2)
- To some extent the threat of trade wars set off by Trump administration, has resulted in volatility in markets and currencies impacting developing countries adversely.
Now that we know the reasons for fall of rupee, we should look at its impact on the fabled India growth story:
- Lower rupee makes cost of petrol and diesel higher: We have seen this play out with lot of news around it. Higher fuel prices can also lead to higher inflation but we haven’t seen any alarming rise in headline inflation which continues to be less than 5% in Sept 18. This is largely in line with RBI’s projection.
- Makes India less attractive in short run for foreign investors (FIIs): The fall of rupee results in lower gains for FIIs in dollar terms. Hence, there could be lower inflows of FII investments into India. However, this time around domestic investors like Indian Mutual funds houses were able to invest more into the markets. SIP inflows have remained steady as Indian investors have not stopped investing in the markets even with this slowdown.
- Makes cars, electronics etc. costlier as they have components which are imported or are fully imported.
However, not all is bad news. Every decade Indian rupee depreciates about 10% to dollar. This fall is in line with the trend. Moreover, there are a few positives that can be garnered from the depreciation of rupee, as follows:
- Unlike 2013, rupee is not the worst performing currency in the last one year. Most emerging markets, China and South East Asian countries have seen currency depreciate this year.(3)
- Falling rupee makes Indian exports cheaper in dollar terms and more competitive. This could give a boost to export sector that has been stagnant for some time.(4)
- Expensive imports encourage domestic industries and production. This should help overall economic growth in country.(4)
- Sectors like IT and Pharma which export their products and services get a profit margin booster due to more rupees earned per dollar. So India’s famed IT giants are expected to benefit from this depreciation.(4)
- Increase value of remittances by 20 million Indians working abroad. For calendar year 2018 it is expected to increase by 10% to $76 billion.(6)
The trade wars and sanctions are part of USA administration’s efforts to get a better deal from its trading partners. It has already settled a deal with Mexico and Canada. China and other partners are in talks to reach an agreement. This should play out in a few months.
Till then, there are even reports that India could overall benefit from this US-China trade standoff. Besides that India remains the fastest growing economy in the world. Hence the long term investor should not be bothered by volatility in markets caused by rupee. It’s in fact a good time for those who were waiting for markets to correct to start planning for their goals.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.