What led to the record fall in the Rupee and how will it impact the economy?

August 8, 2022

The Rupee has come under pressure in the last month, with it breaching new highs of 80 recently. While the rupee has of course weakened, one has to look at it in context of the broader macro environment, specifically the strengthening dollar which is up over 15% versus the Euro and Pound this year, and 20% against the yen. While the rupee has weakened significantly this year it is still a single digit fall versus the greenback. Over the last 5 years, the decline is well within historical averages of an annualised rate of about 4%.

While most emerging market currencies held up well during the pandemic, coming out of the pandemic hasn’t been as kind to them. The heart of the issue lies in the fact that, despite several predictions of the economic world order changing,  the dollar remains the global reserve currency by some distance.

The Federal Reserve is hiking rates aggressively to control inflation. Despite Quantitative Easing being reversed, financial systems are flush with stimulus money from the last 2 years of combating a potential slowdown and supporting various industries. Once you add the supply chain woes caused by the pandemic and the war in Ukraine, one faces a perfect storm of inflation.

The Ukraine War has definitely exacerbated the situation with the US being less effected than other developed and emerging markets given their relative energy independence and ability to withstand the shock. As a result, their growth prospects are less dented and their central bank – the Federal Reserve –  is able to take a more aggressive stance on rate hikes vis-à-vis other global central banks in an effort to curb inflation, thereby softening other currencies.

With the world worried about a recession and a risk off environment, the dollar also continues to surge as money pours into US treasuries as a safe haven. One doesn’t have to look too far back to recall the irony when ratings agencies downgraded the US, only to plunge other currencies and markets further down relative to the dollar. When the largest buyer is in distress, everyone suffers even more.

The result of the rupee weakening is multi-fold and it will be an interesting next twelve months while India and other emerging economies navigate these turbulent times. With petrol and most other commodities such as metals priced in dollars, these items cost more in local currencies across the globe as the dollar strengthens, driving up domestic inflation further and dampening growth prospects. India is not immune to this challenge and I suspect the effect of 10% inflation in the west will take a few months to completely work itself through the domestic economy through price increases. The mitigating factor that India has in its favour is that is does not suffer from labour shortages which are plaguing developed economies, further driving up their inflation.

Secondly, most developing countries have foreign debt priced US dollars, so India as well will owe more than it did earlier this year. India will have to be prudent to balance out its foreign reserves between various demands it has, including supporting the rupee as it just did to stall the most recent slide.

Corporate earnings could also take a hit with domestic companies facing the pinch of raw materials cost and lower profits, resulting in a reduced wealth effect caused to do markets softening.

Silver linings remain with regards to exports, which should get a boost from the weakened rupee. The quantum and timing of this relief will depend on the how fast global economies recover to buy India’s various goods and services.

While most predict a hard landing for global economies, much of this depends on inflation in the west tempering with a recession and dampening in demand not being the main driver. One would hope the next 12 months would finally see supply chain woes settle as the beginning of a chain of events that can help see a global environment with steady growth towards the end of next year, lending stability to interest rates as well as global currencies, including the rupee.