Rupee weakness likely to continue
Dollar may appreciate, as risk aversion would trigger a flight to safety in the near term
Since August, foreign funds have started selling risk assets and returning to the dollar, still considered a safe haven. Consequently, the trade-weighted dollar appreciated 3.5 per cent and the INR is down eight per cent. In times when growth is slowing and inflation stubbornly high, such a flight of capital can be disastrous for India’s balance of payments. According to Macquarie Economics Research, the rupee is likely to remain under pressure in the near term, as India runs a high current account deficit of 2.6 per cent of GDP and a high trade deficit of 7.6 per cent of GDP, as of FY11. Capital flows are critical for India, as it funds its current account deficit through these inflows.
Given that India imports 80 per cent of its oil requirement, slowing capital flows and a falling rupee are not the best case scenario. Given that oil prices continue to rule above $110/barrel, any further rise in crude oil prices will further widen the current account deficit. So far, India has been a BoP-surplus economy, thanks to portfolio inflows. However, forex dealers say this year the BoP is balanced and there is no surplus. This makes India highly vulnerable to any upward movement in oil prices or capital outflows. It’s also important that the current account deficit is capped at 2.8 per cent, if further volatility in the currency is to be prevented.
It’s probably due to this that the rupee has fallen more than the currencies of other emerging markets. The Korean won for instance, has depreciated 5.1 per cent, the Malaysian ringgit has dropped 4.8 per cent and the Indonesian rupiah is down 3.7 per cent against the dollar since August. Clearly, the rupee seems the weakest of all in the emerging market currency basket.