Over the past year, the rupee has dropped nearly 26 per cent against the dollar.

In just the last three months, the rupee has dropped 12.6 per cent, closing at 57.15 to the dollar last Friday. This is the sharpest fall in any quarter for the rupee.

Even during the crisis of 2008, there was not so much depreciation in such a short time. Most companies, especially importers, have found their capacity for tolerance of such volatility stretched.

So why is the rupee going down?

Currencies react to both the fundamentals of demand and supply as well as sentiment. Sentiment is down — a spate of bad news on the economic front — slowing GDP, rating downgrades, policy drift, high inflation, lack of rate cuts etc., contributed to it.

On the fundamentals side, India is a net importer and therefore needs more dollars to pay for oil and gold (its two main imports) as well as other imports. India imported $180 billion more of goods than it exported (last year’s total imports were $480 billion while exports were $300 billion). This greater demand for dollars is of course reduced partially by capital inflows, borrowings, remittances, software earnings etc.

OIL DEMAND

India imports 83 per cent of its oil requirements (last year’s bill was $150 billion). The monthly demand (of $12 billion) on this account as well as rising oil prices has usually kept the rupee under pressure. Apart from oil, there are gold imports for which the country paid nearly $60 billion last year.

Now, ironically, prices of both oil and gold have been coming down — which is expected to have favourable impact on the trade deficit this year. Brent crude prices have dropped to $90 a barrel, a drop of nearly 30 per cent since early 2012. A $1 decline in oil prices should help reduce current account deficit by about $1 billion.

The drop in oil prices has allowed markets to project that trade deficit will be down by $25 billion this year.

Such inferences should in the normal course have led to an appreciation of the rupee. This is something market experts say will still happen — eventually — perhaps in six months to one year.

But in the short term there is a mood of panic and poor sentiment and dire predictions that the rupee is heading for ‘retirement’ — the euphemism for its value touching 60 to the dollar. There is now a unidirectional and sustained downtrend in the short-term, market experts say.

Forex experts say that importers are increasing the tenor of their cover — the protection they buy against a further decline in the rupee. In simple terms, if importers covered their import bills for 2 months earlier, they are now doing it for three to four months. This, they say is contributing to panic, further volatility and uncertainty. In contrast, exporters, revenue earners such as software industries, are not selling dollars that they earn, waiting for the rupee to depreciate further.

HIGH HEDGING COST

The cost of hedging through one-year forward contracts has been high. The forward premium was as high as 6.6 per cent a few weeks ago, before falling to 4.83 per cent just before the RBI policy. The disappointment at not getting the expected cut has resulted in forward premiums once again jumping to 5.5 per cent now. Even CII President, Mr Adi Godrej, told Business Line recently, that the cost of hedging was prohibitively high and he preferred not to hedge.

BUNCHING PAYMENTS

Experts say that bunching of payments by oil companies (for oil imports) in the spot market has increased demand for dollars in the short term. Normally, oil companies avail of short-term buyer credit of between 3-6 months and stagger their payments.

However, with the rupee depreciating so drastically, they prefer to pay their bills immediately rather than buying on credit. This creates a further pressure in an already frayed market.

Normally, the Reserve Bank tries to cool this down by opening a special window for oil companies (so that they don’t buy more dollars in the market) for a short period of time. There has been such talk in the market although there is no official word yet.

The Finance Minister has promised some action and a package of measures from the RBI today. Let’s wait and see.

(This article was published on June 24, 2012)
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