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The rupee is once again under pressure. Following its sharp decline to 60.50 on Tuesday, it has once again moved closer to 60.30.
The Indian currency is down 1.4 per cent in the last five sessions as the escalating civil war in Iraq is leading to fears that India’s import bill will mount with crude oil prices.
Worst-hit currency
It is not surprising that rupee is the worst-hit in the emerging market currency basket in this episode. Indian crude oil import bill for the month of May was $144 billion of the total merchandise import of $392 billion. Brent crude prices have moved from the low of $109 on June 11 to $113.7 currently, a spike of 4.3 per cent.
Besides crude prices, there are other reasons why the rupee cannot strengthen too much in the medium-term.
Dependence of foreign capital flows
The rupee has been on a strong up-move since the beginning of this year as foreign institutional investors brought in close to $10 billion to invest in Indian equity and $9.9 billion in debt markets in anticipation of a change for the better with the new government at the Centre.
But while foreign investors into equity market could be taking a bet on the economic revival and consequent change in company earnings, FIIs investing in debt are more fickle and their investment decisions are closely linked to the currency and interest rate differentials between various countries.
It was observed last year that as the rupee plumbed to the low of 68.8 in August, FIIs had pulled out $12 billion between June and December. Such situations have the potential to develop into a vicious circle. As rupee depreciates on FII pull-out, other FIIs do the same, leading to further depreciation.
These short-term foreign investors also tend to take money back to their home country in periods when risk-aversion soars. If Iraq conflict escalates, money will flow back into US treasury from other countries, as over half of global investors originate from the US.
Current and capital account
There has been much rejoicing of late as the current account deficit for the December 2013 quarter declined to $1.34 billion thanks to clamping down of gold imports. The RBI has recently relaxed some of these restrictions, enabling jewelers to import gold more easily. This is expected to increase our gold imports. Increase in crude prices will widen this gap further.
India has been regularly running a current account deficit since 2005. This deficit has been financed by net receipts in capital account, mainly FDI and FII flows. In periods of turbulence, the entire balance of payment can turn adverse as the inflows on the capital account turn negative.
Forex reserves
The forex reserves currently at $312 billion, is not too comfortable. While this is 13 per cent higher than the low of $275 billion hit in September last year, it is still below the peak of $320 billion hit in August 2011. The reserves are sufficient to service only eight months of imports. This is still below the import cover of 10 months that is preferred.
There are worries on the debt front too with external debt almost doubling from $230 billion towards the end of 2008 to $425 billion currently. Loans taken from overseas have increased 11 per cent since the end of last year. Short-term debt as a proportion of forex reserves stands at 29 per cent.
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