The Hindu Business Line : Rupee-dollar swings

A weak local currency is not exactly good for foreign fund flows into India. For a stock market that is already grappling with dwindling FII flows, a weakening rupee is bad news.

Not so long ago, the Indian rupee was making waves (and headlines) for its steady climb against the US dollar. Exporters, with software companies leading the march, were clamouring for swift action to curb the currency’s rise. Be careful what you wish for!

The rupee has now abruptly reversed direction and is plummeting downwards. Last week, it moved past the Rs 42 to a dollar mark. The recent slide in the rupee’s value has been swift, with a sharp 3.5 per cent ‘depreciation’ in just a week’s time. If a rising rupee was a problem, isn’t a depreciating rupee good? And what is causing all these wild gyrations anyway?

The demand-supply story

To answer the second question first, swings in the rupee, much like swings in the prices of rice or wheat, are caused by the changing equation between demand and supply for the currency. A surge in the demand for US dollars, for instance, prompts people to sell more rupees to receive dollars; this leads to a cheaper rupee. The recent bout of depreciation in the rupee is in fact the result of surging demand for the greenback, from India’s oil importers. Oil prices globally have recently hit a new record.

With most of our crude oil requirements being met through imports from overseas, rising prices of crude oil mean that domestic oil companies will need more dollars to fund their purchases. This triggers rupee sales and dollar purchases, weakening the value of the rupee. Thus, the recent spike in global crude oil prices has indirectly contributed to making the rupee cheaper vis-vis the dollar.

Factors galore

However, the rupee’s swings are not always so easily explained. Oil prices have been the prime villain in this episode; but there are actually a whole host of factors that can tug at the currency in either direction. Rising crude oil prices apart, a surge in India Inc’s imports, an outflow of funds from India due to FII pullouts or a big ticket overseas buy by an Indian company, can all be factors which can pressure the rupee. Conversely, the rupee can receive support if crude oil prices fall (trimming the import bill), NRIs repatriate dollars back home or foreigners step up investments in Indian companies or its stocks. All these increase the incoming flood of dollars and go to strengthen the rupee.

To add to the complications, India’s central bank, the RBI, is also an important member of the cast. Based on its assessment of the economy and perception of whether the Indian currency is overvalued or undervalued, the central bank may step into the forex market to mop up or release dollars. All this is fine. But should the recent decline in the rupee’s value worry you?

In some respects, it should.

What a depreciating rupee means

A cheaper rupee pegs up the cost of every commodity or input that India imports from overseas. Oil is the biggest item on that list and we all know that a higher oil bill will eventually trickle down to us in the form of higher petrol and fuel prices, apart from higher air fares. Crude oil apart, there are other food products too which India imports in substantial quantities. Edible oil is one such commodity. For companies that rely mainly on imported inputs to manufacture products, a weakening rupee escalates costs. Companies manufacturing a range of consumer goods, from soaps and detergents to computer and electronic goods may feel the pinch from a weaker currency. Companies which borrowed abroad may also have to shell out more by way of repayments, should the rupee continue its slide.

A weaker rupee also trims the effective returns that foreign investors earn from investing in Indian stocks and its companies. A weak local currency, therefore, is not exactly good for foreign fund flows into India. For a stock market that is already grappling with dwindling FII flows, a weakening rupee is bad news.

But a steadily weakening rupee may offer a silver lining for those who work for IT or BPO companies. If an appreciating rupee made the export of software services more expensive and rendered our IT giants less competitive against their peers, the tide may now turn with the rupee in reverse gear.

However, before jumping to any conclusions, do keep in mind that it is the sustained trends in the rupee against foreign currencies, rather than its day-to-day gyrations, that will make all the difference.

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