The Depreciating Rupee is Telling a Story

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Since the last month, the rupee has been tumbling, gaining grip only once in a while. Though the value of a currency paints a picture of the country's economy, there is more than one connecting factor that is causing the volatility.

The Depreciating Rupee is Telling a Story

Crude Oil Prices Skyrocketing

Brent, the benchmark for international oil prices hit $80.18 a barrel today, its highest ever since November 24, 2018. As we know, the increase in oil prices means that India's import costs will go up as it depends on other countries for over two-thirds of its supply of fuel to meet domestic demands.

When fuel prices went down in 2014 from increased output, OPEC decided to reduce production to help protect their shared interests (as these economies are mainly driven by fuel exports).

However, geopolitical tensions like Venezuela's economic crisis and Trump's success in sanctioning Iran's crude imports were not anticipated, which makes it highly possible that India's import budget may have been undervalued. This takes us to the next factor- trade deficit.

Trade Deficit

It is a situation wherein a country's imports are higher than exports, meaning we are spending more than we are earning. Recent reports released by the Indian government showed that our exports were growing higher along with our imports, but when you have an irreplaceable import item that keeps getting expensive, it won't help.

What we also need to understand is that India is an emerging economy. Developing countries like our own are highly volatile and fragile to many changes around the world as our financial markets are not as advanced or matured as developed economies like the US or Europe. Any pressure like increased interest rates in the US could easily influence our markets greatly. At the same time, what attracts foreign investors, is the high returns from our potential to grow (in manufacturing for example) amidst risk, which established countries like that in Europe or North America have exhausted.

While American markets are expected to give you a standard growth result, China or India could give you massive gains if things go well.

Appreciating US Dollar

The US economy has improved (it reported an increase in domestic output and spending for April 2018), which led to its Federal Reserve (the equivalent of RBI) halting its money supply (because it has sufficient inflows). Constrained supply strengthened the dollar. To add to it, this allowed the Fed to increase interest rates, which means US treasury bonds/notes would give an investor higher returns.

Just today, US-treasury bonds hit a 7-year high of 3.10 percent and could go further if the bond sales demand grows higher.

And how is this bad for India or the rupee?

Foreign investors are now looking for dollar-based investments that will give them stable returns unlike emerging markets which experts suggest is like "catching a flying knife" at present. Other factors favouring the US dollar include Italy's political situation at the moment (making Euro less favourable) and reports of reduced GDP in Japan (which is expected to grow slowly in the coming quarters).

Negative growth in foreign investment

Between 2015 and 2017, India was seen with optimism by foreign investors, who, brought in capital inflows worth $59 billion in those three years. In 2018, however, there has been an outflow of $12 billion (which means negative growth).

As a strategy, these investors look at the strength of the currency as the basis, so as of now, the dollar is more stable and stronger than the Indian rupee.

The rupee may be slowly recovering through RBI's intervention, but with increasing oil prices expected to hit $100 a barrel by the end of the year, we may be more exposed to more uncertainty.

Read more about: rupee
Story first published: Thursday, May 17, 2018, 21:44 [IST]
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