The steep depreciation of the rupee against the dollar will intensify inflationary and fiscal pressures in India. This will pose additional constraints on the monetary policy response to the current growth slowdown, international rating agency, Moody’s Investors Service, said in a report sent to research clients.

Between May 15 and July 15, the rupee fell 9.3 per cent against the dollar, losing more than 7 per cent this year, the worst performance in Asia after the yen. This prompted the Reserve Bank of India to take steps to tighten liquidity in the banking system.

Economic factors

Over the last two years, the rupee has depreciated 17 per cent against the dollar. Titled “India: Answers to frequently asked questions about the credit impact of rupee depreciation”, the report notes that recent RBI measures to stem currency volatility could arrest the pace of depreciation.

But chances of a significant near-term appreciation this year are limited, the report said. This is because of the extended growth slowdown, continued global financial volatility and domestic political uncertainty ahead of the 2014 general elections.

As for how depreciation will affect India’s sovereign credit profile, Moody’s has noted that foreign currency denominated debt was about 6 per cent of total Government debt.

So, depreciation will not materially increase the sovereign debt repayment burden. However, depreciation will exacerbate inflationary and fiscal pressures, both factors that could impact India’s Baa3 rating. The steep fall in the rupee could increase debt repayment and input costs for some firms, adding to current economic stress, the Moody’s Investors Service report said.

Since non-Government external debt is a relatively modest 16 per cent of GDP and is not the primary source of financing for much of the private sector, the credit impact of depreciation will be greater on specific firms than on the larger economy.

Given the subdued global growth outlook and price inelasticity of certain major imports, depreciation is unlikely to accelerate export growth or curb import growth significantly in the near term.

not unprecedented

The report points out that rupee depreciation is not unprecedented and that the exchange rate reflects the growing interface between domestic and global trends as India’s trade and financial openness increases.

Benign global liquidity conditions and high domestic growth supported an 18 per cent appreciation of rupee against the dollar between 2001 and 2007.

Then, international financial volatility contributed to the rupee depreciating 27 per cent against the dollar over the course of 2007-08.