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Rupee’s under pressure. But the outlook is excellent

The Indian currency fell over 7% in 2022, driving inflation and reducing margins for importers.

Chakradhar Chemicals, a chemicals manufacturer and agricultural equipment, has made great strides this year. However, a sharp rise in the cost of imported raw materials (metals and plastics) plus a sharp fall in the rupee drastically reduced the company’s revenue.

But the top management of Chakradhar Chemicals is relatively calm. And it’s no surprise. Commodity prices have normalized. The yuan, the currency of Chakradhar Chemicals’ trading partner, also fell.

Global investors flee to US assets

The Russia-Ukraine conflict has caused the capital outflow into American assets, followed by a decline in most world currencies.

Global shortages of goods and supply chain disruptions due to the pandemic and military operation, as well as unprecedented Western sanctions on Russia, have sent inflation to unprecedented levels in all countries.

While economies are tightening their monetary policies to curb inflation, recession fears have led global investors to shift away from emerging market assets.

The US has become the only safe haven in the current international climate.

And here, we are talking about safety, not profitability.

The decrease in dollar liquidity against the backdrop of aggressive monetary tightening by the Fed strengthened the dollar, which triggered a sharp depreciation of most world currencies. Earlier this month, the euro hit parity with the dollar and fell even lower for the first time in 20 years. That is why European assets are also not an option for global investors.

Impact on India

A weaker rupee adds to the importers’ bills and affects domestic prices through imported inflation. Home price increases and rupee depreciation proved to be a fatal combination for the inflationary situation in the country, given that most of its oil is from other countries.

As a result, the rupee depreciated by more than 7%, affecting ordinary Indian citizens and their basic needs.

Chart 1. The rupee depreciation compared to other world currencies, %. July 2022.

Rising food and fuel prices have pushed household expenses up, with 32% of Indian households struggling to make ends meet and 11% unable to feed themselves, according to Kantar Group. About 71% of respondents believe inflation will continue to rise.

Rupee is still overvalued compared to its Asian peers

Economies are facing currency depreciation around the world. But the rupee, despite everything, is still one of the most efficient currencies in the world.

In August 2019, the national currency exchange rate crossed the mark of 70 rupees per dollar. While breaking the new low at 80 is a landmark moment, analysts suggest, there is still no cause for concern since a drop below 80 will not affect India’s economy much.

Abhik Barua, chief economist and executive vice president of HDFC Bank, said the combination of currency depreciation and strong inflation is putting pressure on the economy. But the recent decline in global commodity prices has benefited the economy and helped mitigate the rupee’s devaluation.

Rupee fall makes exports competitive

Abhik Barua notes that since the rupee has depreciated less than some of its trade peers, some more rupee depreciation could even benefit Indian exports. Exports will become more competitive, offsetting some of the trade deficit in favor of India’s balance of payments.

The real effective exchange rate (REER), which values ​​the rupee against a basket of 40 currencies, stood at 104.18 in June. This is the level at which the rupee is still overvalued.

While exporters have already profited from the sharp fall in the rupee in 2022, a further decline could make their goods more attractive globally, given that the geopolitical crisis in Europe has expanded the opportunities for Indian exporters.

Animish Saxena, managing director of Neetee Apparel, a small manufacturing arm that exports clothes, says that while his company saw an additional profit of 20-30% in dollars, other companies were able to increase profits by almost 50%.

Graph 2. USD/INR and REER. January-June 2022.

Great prospects ahead for rupee

The Central Bank of India is actively selling dollars in the Forex market to ease the rupee’s fall. The effort has already led to a drop in the country’s foreign exchange reserves by $61.77 billion from the price maximum in the first week of September. The Central Bank is preparing for further Forex interventions and is ready to sell $100 billion shortly.

The Reserve Bank of India is also actively engaging with foreign exchange market participants to allay rupee depreciation fears, stressing that with $580.25 billion in reserves, India is well prepared to hedge against sudden exchange rate drops.

Among the various regulations announced earlier this month, one is special. The Central Bank has been encouraging Indian entrepreneurs to price Indian exports and imports in rupees rather than dollars.

While India still has a long way to go before the rupee gains acceptance as a global currency, analysts believe it will certainly open up opportunities for deeper engagement with countries that benefit from reducing the dollar’s usage in international trade. These are, first of all, Russia and China.

Payments in rupees are of particular interest to India as they allow to curb dollar outflow and cover for large-scale import costs: energy raw materials and military goods.

Russia helps the rupee grow

Russia sells oil at lower prices to India and China. While India’s trade deficit is under pressure, rupee-paid imports from Russia are a boon for the Indian economy.

If India can pay for all Russian imports in rupees, it will provide long-term support to the Indian national currency.

Excess rupees could be invested in government bonds to offset some of the foreign investors’ losses.

If India replaces its dollar-settled oil imports from Saudi Arabia with rupee-settled imports from Russia, import costs might drop significantly.

Such a scenario could sustain the rupee in the long term!

And this Indian de-dollarization process is already in full swing.

Thus, in the context of a substantial discount on Russian oil, India has already increased the volume of crude oil imports from Russia by 4.7 times year-on-year (by more than 400 thousand barrels per day) in April and May 2022.

As a result, Russia’s share of Indian imports increased to 11% in April from 3% in 2021.

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