The geopolitical conflict between Russia and Ukraine, raging since February 24, has sent global financial and energy markets into a deep recession. On the home front, things went further south recently when the Indian rupee, while outperforming the euro and the Japanese yen, began trading below the psychological level of 80 against the US dollar. This has been attributed to factors that include tightening monetary conditions, soaring crude oil prices, Russia-Ukraine conflict, and persistent outflows from domestic markets in the aftermath of high imported inflation.
The Reserve Bank of India recently implemented a new mechanism for invoicing, payment, and settlement of export/import transactions in Indian Rupee (INR). It is a small step toward reducing India’s reliance on the dollar. While this decision will have a little immediate impact, it will benefit the country in the long run.
Magnitude of weakness
However, one must understand the magnitude of the weakening of the rupee; the scenario is beneficial to the country’s exporters and not the importers. Almost three-fourth of the inflation pressure is said to stem from imports and energy prices. The import of commodities like coal, plastic, chemicals, vegetable oil, fertilisers, gold, pearls, precious, semi-precious stones and iron and steel are also affected.
While it makes imports more expensive for Indian consumers, it increases the demand for home-grown products albeit making it also relatively cheaper. This, in turn, could benefit certain domestic firms that face stiff competition from cheaper imports. Furthermore, it will increase the competitiveness of domestic industries and provide India with the opportunity to achieve self-sufficiency, which is consistent with Prime Minister Narendra Modi’s vision of making India AtmaNirbhar.
Interestingly, India and the US are on the same page when it comes to reshoring to fight inflation as manufacturing at home or importing from neighbouring countries is perceived to be a way to build resilience among supply chains. A new University of California San Diego School of Global Policy and Strategy research also states that the US prefers nearshoring, where you outsource operations and services to a company in a nearby location. The research also suggests that most firms prefer to offshore during a crisis as it means hiring low-cost suppliers at a large scale from another location, which in turn keeps the costs down.
Rising international crude oil prices are undoubtedly the primary cause of the rupee’s depreciation. India is impacted largely by this factor because it is a major crude oil importer, accounting for roughly 80 per cent of total imports. It’s high time to shift focus to electric vehicles (EVs) as an alternative to oil. However, many components, including the lithium-ion cells, which are important in the making of battery packs are fully imported into India, this makes it even more imperative for importers to put into effect the Make in India vision and encourage local manufacturing. They can explore government’s initiatives like the FAME (Faster Adoption and Manufacturing of Hybrid & Electric Vehicles) scheme, which encourages sourcing components in India.
The volatility in the currency markets has predictably seen a surge in demand for hedging instruments. Apart from impacting their financial decisions and stocking strategy, there is a rush among private players to buy currency hedges. It is not surprising that importers are jumping into the market to buy currency hedges as it helps them to cover their currency risks to protect margins.
The recent move by the RBI to settle trades in rupees as India has a trade deficit (where imports exceed exports) has been welcomed. It will not only reduce dollar outflows, but also does away with SWIFT payment systems. Secondly, from a long-term perspective, such measures will encourage gradual and incremental shift to greater use of the rupee in foreign trades.
These measures also help the country to trade with sanction-imposed trade partners like Russia and also facilitate trade with country like Sri Lanka having very low forex reserve to pay for its imports.
While these steps taken by the government raise the country’s expectations, there are more reasons to look ahead with hope. Despite the crisis, imports in India, according to Trading Economics global macro models and analysts, are expected to be $55 billion by the end of this quarter. This, coming as it does, at a time of uncertainty, importers have much to look forward to and celebrate!
The writer is Immediate Past President, ASSOCHAM