The rupee's journey from 40 to 80 per dollar

Those who have been tracking the rupee over the past two decades would recollect that it had appreciated from 49 to under 40 against the dollar between 2002 and 2007. There was a lot of chatter around the 40 level that the rupee was heading towards 35. It was an era when exotic derivatives were in vogue and several exporters had put on leveraged derivative structures, betting on the rupee strengthening. Thereafter, came the financial crisis of 2008 which resulted in huge losses on exotic derivative products for many exporters. 

The rupee weakened past the 40 mark and went all the way to 52 in no time, and has been depreciating steadily ever since. And the journey from 40 to 80 translates into an annualised pace of depreciation of about 5 per cent, which is about the same as the average one-year forward yield during the same period, suggesting that the rupee has broadly depreciated in line with the interest-rate differential between India and the US.

The year 2008 was the worst year for the rupee (-23.8 per cent), followed by 2013 (-12.4 per cent and 2018 (-9.2 per cent), while 2017 was the best year (+6 per cent). During 2008-2022, the rupee has been the worst-performing Asian currency, depreciating almost 50 per cent against the dollar. The Indonesian rupiah was the second-worst performer, weakening 39 per cent against the dollar. The above statistics however do not do justice to the resilience that the rupee has developed to external shocks over recent years.

The rupee has progressively become overvalued in real terms against a basket of currencies of India’s trading partners. Over the years, its movement has got more aligned with the broader dollar.

The three-month implied volatility, which is representative of the uncertainty in the rupee, barely touched 10 per cent despite the unprecedented twin shocks of Covid and the Russia-Ukraine war. This measure had spiked to as high as 20 per cent during the subprime mortgage crisis in 2008 and to 15 per cent during the taper tantrum in 2013. Also, the rupee has progressively become overvalued in real terms against a basket of currencies of its trading partners. Over the years, its movement has got more and more aligned with the broader dollar.

Enroute to 80, India has cemented its place as a reliable trading partner and an attractive investment destination in the global arena. On the balance of payments (BoP) front — before Covid and the Russia-Ukraine war — the trade deficit had stabilised at 5-5.5 per cent of GDP and the current account deficit at 0.5-1 per cent of GDP, which is considered to be quite manageable. Our services-sector exports have grown remarkably over the years, hitting the $250-billion mark in FY22.

India also continues to be the biggest recipient of remittances from abroad. On the capital account front, foreign direct investments have risen for nine consecutive years and hit $83.5bn in FY22, a record high. India’s representation in global equity indices, too, has increased over the years. The most striking change has been in the central bank’s approach to managing currency.

The build-up of a war-chest of forex reserves during good times is proving to be extremely helpful in managing volatility during the current unprecedented BoP stress. A stable rupee also reduces the risk premium that foreign investors expect for investing in Indian assets. It automatically pushes up the valuation of Indian assets. It is no surprise that as our reserves-to-external-debt ratio has increased, there has been a steady decline in exchange rate volatility. 

Giving Indian banks access to non-deliverable forwards (NDF) through GIFT city, and the central bank beginning to intervene in NDF has been a game-changer. We expect volatility in the rupee to remain contained. We believe the central bank will continue to focus on reserve accumulation as the flow picture turns around. It will endeavour to keep the rupee competitive, especially against the yuan, to give a fillip to exports and domestic manufacturing. Expect to see an average 1.5-2.0 per cent annual depreciation over the coming five years.

The writer is founder and chief executive officer of IFA Global