Data dive: Should RBI let the rupee fall?

The depreciation of the rupee has always been a political hot potato even though it is a natural trend for an emerging market. The rupee’s value is currently at a low, triggered by the strengthening of the US dollar since Donald Trump’s victory in the presidential election. The president-elect’s anti-immigration stance and call for higher trade tariffs have caused nervousness worldwide and is reflected in major emerging-market currencies.

The rupee has depreciated 0.4% since 5 November, holding up better than its emerging-market peers. Even as Trump’s victory has led to volatility and uncertainty, his previous administration saw moderate weakness in the rupee. During Trump 1.0, the rupee depreciated only 6.7%, milder than the 15.3% weakness seen during Joe Biden’s presidency.

To smoothen the fluctuations in the rupee – either a sharp appreciation or depreciation – the Reserve Bank of India (RBI) has often intervened in the markets with its massive kitty of foreign exchange reserves. However, with markets volatile following the rate cut by the Federal Reserve and Trump’s victory, forex reserves have declined after hitting an all-time high of $704.89 billion in the week that ended on 27 September.

Also read | The week in charts: Climate maths, rising inflation, crypto price

Several experts including the former chief economic advisor Arvind Subramanian have questioned the RBI’s intervention, while many economists have argued for a weaker rupee to boost trade competitiveness.

However, the flip side is that a weaker rupee could induce inflationary pressures and a sharp fall could worsen India’s fiscal and current account deficits.

Rupee’s route

The rupee will keep depreciating, with its value expected to breach 85 to a dollar over the next few months, economists said. “The rupee’s performance is much better than that of other currencies, but the RBI is taking the initiative of letting the rupee depreciate at a gradual pace with each passing day,” said Radhika Piplani, chief economist at DAM Capital, who believes the rupee is overvalued to some extent. “I think everyone in the market is mentally prepared for the rupee to cross the 85 level in the next two to three months,” Piplani added.

Also read: The changing pecking order in semiconductors

While a faster pace of weakness in the rupee in recent weeks may have led to nervousness, the State Bank of India noted in a report on 10 November that fears of a sharp depreciation were unfounded. The bank expects 8-10% depreciation during Trump’s second stint. While the depreciation in the rupee provides an advantage to exports, a 5% decline may lead to an increase in inflation by only 25-30 basis points.

The bigger issue is the Chinese yuan, which has weakened sharply compared to the rupee, making a case for further depreciation in the Indian currency to keep it competitive in the global market.

Currency calculation

The rupee has hit new record lows in the past few days but its weakness has been milder compared to currencies of other emerging markets. The rupee has depreciated 0.4%, while the Chinese yuan has fallen 1.7%, the Thai baht has weakened 3.6%, Malaysian ringgit 2.9% and the Mexican peso 1.5% against the US dollar. This seems to have started a conversation among policymakers about letting the rupee depreciate further – though not abruptly.

According to a report by Bloomberg, the RBI may be ready to let the rupee weaken in line with the Chinese yuan to contain the trade deficit with the dragon. “If the yuan weakens significantly, the RBI does not have a lot of options but to let the rupee decline as well,” said Dhiraj Nim, forex analyst at ANZ. “However, the RBI would not let it happen abruptly. They would want to smoothen the depreciation in line with their recent strategy,” Nim added.

While the rupee will continue to depreciate in the coming years, the extent of this will hinge on what kinds of policies Trump pursues. If the US imposes tariffs on India as well, the rupee will have to weaken to counter their impact.

Also read: How FDI flows into India lost momentum