Rupee's 8% fall to drag down macro fundamentals

Inflation may rise by 60 bps, while CAD may inch up by 0.4% of GDP

The rupee's sudden fall (8%) since May isn't good news for the country's weak macro-economic fundamentals.

A weak rupee will have material impact on inflation, current account and the fiscal deficits. Given that India imports far more than it exports, any weakness in the local currency would push up the import bill, especially the oil import bill.

The respite that the economy and corporates have got from falling commodity prices will be offset by the currency's weakness.



The most immediate impact of expensive imports would be on the inflation indices. Global commodities have a 35% share in the Wholesale Price Index basket, a depreciating currency would push up inflation.

According to economists, the higher-than-expected inflation would further weigh on the rupee. A 10% weakness in the currency could push up inflation by 60-80 basis points. Any upside risk to inflation would restrict Reserve Bank of India’s from cutting rates any further.

Jyotivardhan Jaipuria and Anand Kumar of Bank of America Merrill Lynch believe the rupee's volatility raises near-term risk to inflation and to a rate cut this month.

And since the government continues to subsidize gasoline in India, oil subsidies would rise by Rs 8,300 crore for every one rupee’s depreciation. Assuming that the government funds half of the oil under-recoveries, the oil subsidy burden should rise by around Rs 4,200 crore (0.04% of GDP) for every rupee depreciation, says Sonal Varma of Nomura.

It is estimated that a 10% fall in the rupee against the dollar could bump up fiscal deficit by about 0.2% of GDP, if everything else being constant.

It’s not just the fisc that will come under stress. A weak currency would put stress on the current account deficit, as the India’s imports are not price sensitive and are largely inelastic. A one rupee fall in the domestic currency would push up the current account deficit by 0.4% of GDP.

Impact of 10% depreciation in INR
Macro Variable	Impact
Current Account Deficit	0.4% of GDP
Fiscal Deficit	0.2% of GDP
WPI Inflation	60-80 basis points
Source: Nomura Global Economics estimates