Rupee depreciation, inflation, triple whammy of RBI rate hikes for businesses and consumers; INR could reach 78.5 in 2 months
By Amit Pabari
After surging sharply as high as 76 levels against the dollar, the Indian rupee hit an all-time low on May 9 and extended its slide towards 77.62 on Friday as the strength of the US dollar index weighed on demand for the riskiest assets and currencies and that foreigners continued to withdraw their stocks and bonds. Throughout the week, RBI tried to keep the currency from slipping but still closed down 50 paise for the week.
In the United States, whether it’s the jobs report (pre-pandemic low), inflation (40-year high), annual growth (37-year high) or basic data on personal consumption expenditure (reaching a 31-year high in February), all are supportive of a stronger US dollar index.
On the emerging market side, faster US rate hikes, huge FII outflows, rising commodity prices and soaring inflation have prompted central bankers to opt for a rate hike and jeopardize their growth. Apart from that, the trade deficit and budget deficit are also widening month on month. For this reason, many emerging currencies have depreciated over the past month and a half. The Rupee outperformed in April, but has now started to depreciate in May and is expected to decline further in the short to medium term.
In given contexts, RBI’s foreign exchange reserve and FDI flows could only be positive pints. The central bank has used nearly $43.73 billion over the past eight months amid capital outflows and a strengthening US dollar. This suggests that RBI will try to regularly monitor the depreciation move and it remains to be seen how they navigate with these numbers in mind. As interest rates are likely to rise, companies and banks are likely to raise funds abroad at a lower rate, and FDI flows could therefore increase. This could prevent the Rupee from weakening against the USD.
According to the Fibonacci extension, it is possible for the pair to test the 78.50 levels in the near term. On the contrary, a breakout of 76.95 to 77.00 will act as strong support, followed by the 76.50 levels.
Higher inflation, rising RBI rates and depreciating Rupee are creating a triple whammy effect on domestic businesses and consumers.
Until now, there was only one concern in front of everyone: “inflation”. But in the past two months, two more factors have been added: “the hawkish stance of RBI” and “the depreciation of the rupee”.
Impact on investment
Higher inflation eats away at the return of the investment and therefore the real return decreases. Also, if a country’s currency is on the weakening side, then definitely, withdrawing the investment becomes more costly. So why would foreign investors stay longer and keep their investments in your country when your inflation is over the limit and the currency is falling.
Rising inflation globally has been a headwind for businesses as their commodity prices have become more expensive by the day. Import prices were also increasing. As the economy was in the recovery phase from the COVID pandemic, unfortunately they were unable to pass it on to the consumer. Thus, they take a hit by reducing their profit margin. Another point that will now affect businesses is rising RBI rates. Due to higher interest rates, their working capital loans become more expensive and the load increases on balance sheet ratios. Rising interest rates also affect stock valuations as the discount factor increases.
Impact on consumers
As producers continue to pass on higher prices to consumers, the household ends up having less savings with them. Raising rates by RBI also increases the cost of their loan as the base rate or benchmark rate increases. And last, the depreciation of the rupee makes imported items expensive. This includes smartphones, laptops, televisions, refrigerators and even some basic necessities that rely heavily on imported raw materials. The student visiting abroad for study or the citizens touring abroad will also have to pay extra as the local currency is under pressure.
Indian Rupee Outlook
Overall, deteriorating fundamentals like widening trade/CAD/fiscal deficit, rising inflation and weakening emerging market currencies will keep pressure on the rupiah. RBI might regularly step in and calm the nerves, but a steady depreciation towards 78 and 78.50 is imminent over the next two months. The probable range in the short term would be 76.50 to 78.50. The negative impact of the same on investment flows in the country, businesses and consumers will surely be terrible.
(Amit Pabari is the Managing Director of CR Forex Advisors. Opinions expressed are those of the author.)