Charting the rupee in a VUCA world

The Economic Survey has highlighted the tough times that the Indian rupee underwent in 2018-19 and the factors that led to the turbulence.

The numbers help us understand the manner in which the RBI handled the crisis and supported the rupee last year. But there is no action plan outlined for bolstering the rupee in the years ahead.

Also, some new ideas to address the risks that consistently threaten the Indian currency would have been welcome.

Charting 2018-19

The Survey has done a good job of sketching the rupee’s path in FY19.

While the currency had been on a firm footing in FY18, trading between 63.63 and 65.08 against the dollar, there was a steep depreciation last fiscal with the rupee hitting a record low of 74.4, before ending the fiscal year at 69.2.

The reasons that pulled the rupee lower were increase in crude oil prices and foreign portfolio outflows that resulted in widening the current account deficit.

But the situation improved by the third quarter as crude supplies increased and the Federal Reserve paused interest rate hikes as global growth threatened to slow down.

2018-19 was among the most volatile years, in recent times (volatility as measured by the standard deviation of the highest and lowest monthly change in a year).

Exchange rate volatility spiked to 2.3 in FY19 after staying subdued at 0.4 and 0.6 in FY17 and FY18.

The rupee lost against most of the major currencies last fiscal including the dollar (-7.8 per cent), the GBP (-6.8 per cent), the euro (-6.8 per cent) and the yen (-7.7 per cent).

Forex/RBI’s measures

It is, therefore, not surprising that the forex reserves witnessed the steepest erosion in FY19. It had reduced by $29 billion between April and December 2018. While $17.5 billion can be accounted for by the imbalance in balance of payment, $11.5 billion was due to erosion in the value of rupee.

The RBI had to net-sell $15.577 billion in FY19 in order to help the falling rupee. The highest sales were in May, June and October 2018.

The RBI’s bid to inject rupee liquidity for longer duration through long-term foreign exchange buy/sell swaps in March 2019 resulted in increasing the reserves by $5 billion. If this number is taken out of consideration, the net sale would be much higher.

Too sanguine

While the Survey has got it right looking at the rear-view mirror, it appears to be shrugging aside the concerns that loom ahead in FY20.

It says that based on the WEO’s April 2019 forecast of accelerated world output in the second half of 2019, the outlook could get better.

The caveats for ensuring a more stable FY20 — continued accommodative monetary policy stance in advanced countries, fiscal stimulus in China and de-escalation of trade tensions between the US and China — are not that easy to envisage.

Also, benign foreign portfolio flows in FY19 have been largely instrumental in ensuring rupee stability this fiscal.

These can reverse if global central banks begin monetary tightening again or foreign investors grow more wary of the expensive valuations in Indian equity market. The Survey is also overlooking the growing external debt that stood at $543 billion in March 2019. This is a point of concern, especially since short-term debt accounts for 26 per cent of forex reserves.

While mentioning the possibility of crude prices moving higher, in line with higher global demand, the Survey says that this can be compensated by higher exports.

A more realistic assessment would have been more useful.

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