The RBI is faced with a triple whammy of low economic growth, high inflation, and till recently, a weakening of the rupee vis-à-vis the dollar and other major currencies.
Recent NSO data show that India’s GDP growth decelerated to 6.3 per cent in Q2 FY23, with a significant contraction of 4 per cent in manufacturing. On the inflation front, though the CPI has eased to 6.77 per cent in October from 7.41 per cent in September, it is still above the RBI’s upper tolerance level of 6 per cent for the seventh straight month.
The rupee has depreciated by more than 10 per cent since January, and is hovering around ₹82 against the dollar currently.
On the global front, the rupee has weakened due to quantitative tightening and interest rate hikes by the US Fed, leading to a continuous outflow of FII funds (amounting to $18.5 billion in the current calendar year, with an uptrend of late). Foreign portfolio flows have resumed in recent months and were positive at $ 11.8 billion during July-December 2022, led by equity flows, according to the RBI Governor’s recent MPC statement.
The strengthening of the dollar index (which expresses the greenback’s strength against a basket of six currencies) by around 16 per cent this year also explains the rupee’s fall. Besides, the Russia-Ukraine war, followed by the sanctions on Russia, and the economic slowdown in China have put further pressure on the rupee.
India’s persistent CAD, led by the rising prices of commodities and crude in the international markets and spurt in non-oil and non-gold imports, underlines the inherent weakness of the currency.
Notwithstanding the RBI Governor’s statement that CAD is likely to fall in H2 FY23 due to a rise in services exports and higher inward remittances, many analysts predict the rupee to fall further to ₹85 a dollar in the near future.
Painful impact
While rupee depreciation does not spell doom, policymakers need to address its painful consequences.
A recent paper by Swapnil Suryavanshi in the Economic and Political Weekly concludes that between January 2013 and June 2019, the impact of exchange-rate pass-through (ERPT) has been the highest on WPI, followed by CPI and core inflation.
Besides, corporates with substantial foreign currency debt will face balance-sheet problems, as depreciation would raise the rupee costs of servicing debt in foreign currencies. As per the RBI, Indian firms had around $79 billion of unhedged offshore loans at the end of March 2022, accounting for 44 per cent of their total overseas borrowings. These unhedged borrowings remain exposed to exchange rate risks, which can exacerbate the financial vulnerability of these firms.
While a currency depreciation in general benefits the exporting sector, such benefits might not materialise given the current global and domestic conditions. Over the past decade, India’s export basket has witnessed a clear shift from price-sensitive items to income-elastic items like refined petroleum, chemicals, diamonds etc. Further, the high domestic price levels can nullify the export competitiveness of Indian firms.Thus, in the current context, the costs of rupee depreciation far outweigh the benefits.
Sur is Assistant Professor, Jindal Global Law School, OP Jindal Global University, Sonipat; and Nandy is Assistant Professor, Indian Institute of Management, Ranchi