Why the rupee is on a slippery wicket

The rupee’s sudden fall on Friday, amounting to 1.4 per cent, took the currency market by surprise.

The Indian currency had been gradually appreciating against the dollar since the beginning of this year, gaining almost one per cent, until February 25. The rupee’s strength was mainly due to the weakness in the dollar and foreign portfolio inflows in the equity market.

But the mayhem in financial markets towards the end of last week has reversed these gains.

While the rupee has been steadily appreciating against the greenback since last April, the performance of the Indian rupee compared to other emerging market currencies is quite weak.

For instance, the Chinese yuan, Taiwanese dollar, South Korean won and Philippines’ peso have appreciated over 4 per cent against the dollar since the beginning of 2020, while the rupee is down 3.3 per cent in this period.

The RBI’s US dollar purchases to bolster its reserves could be one reason for the rupee weakness. But there are other inherent problems dogging the rupee.

FPI flows in debt

The primary reason behind the rupee’s plunge on Friday was the spike in the bond yields in the US and other countries on the expectation that growth will revive and inflation will pick-up.

The connecting link between US bond yields and the rupee is — FPI inflows in Indian debt. The rupee is extremely sensitive to the fund flows into the debt market.

Foreign portfolio investors pull money out of Indian debt when yields on Indian bonds spike or increase in their home country. The outflows put pressure on the Indian currency, making it weaker.

A case in point is the events in August 2013, when the rupee had come under severe pressure even as Indian 10-year bond yields moved beyond 8 per cent.

Foreign investors have been wary about India’s burgeoning fiscal deficit and the uphill task that the Centre faces in financing this deficit, for some time now.

It needs to be noted that FPIs have net sold ₹1,04,873 crore of Indian debt in 2020 and had followed it up with net sales of ₹9,864 crore in 2021. But the copious inflows into equity markets had mitigated the impact of the debt outflows so far.

Rise in commodity prices

The other problem facing the rupee is the increase in crude oil prices, which are up around 30 per cent since the beginning of this year due to reduced supply from OPEC plus countries and revival in demand.

With India importing over 80 per cent of its crude oil consumption, the spike in prices has a debilitating impact on the trade deficit and the rupee.

Besides crude, prices of other metals, including copper and steel have also been increasing. The CRB index of all commodities is up around 7 per cent since the beginning of 2021.

What’s ahead

Bond markets have cooled down with the US Senate passing the $1.9-trillion stimulus bill and global central banks allaying monetary tightening fears in the immediate future.

But the large debt taken on by all countries during the pandemic will weigh heavily on the bond and currency market in the months to come. The rupee is expected to remain volatile under these circumstances.