The rupee touched a new all-time low of 69.13 against the dollar on Friday. The depreciation in the rupee has been on account of several factors.
Monetary policy tightening
Monetary policy tightening by the US Federal Reserve has resulted in the dollar strengthening. The US economy has been doing well and with inflation showing signs of picking up, the Fed seems keen to move towards a neutral rate sooner rather than later to prevent excesses from building up in financial markets. On account of rising short term rates in the US, foreign portfolio investors (FPIs) have deserted domestic bond markets and have been net sellers for six straight months.
Elevated crude prices
Elevated crude prices have been responsible for India’s worsening current account balance. A $10 per barrel increase in global crude prices raises headline inflation by 40-50 bps and shaves of 0.1 percent from India’s GDP growth. Exports have not picked up in line with global growth due to Goods & Service Tax induced disruptions.
Ongoing trade-related tensions between the US and China have dampened risk sentiment and outlook for global growth. The most recent leg of the rupee depreciation versus the dollar has been on account of weakness in the yuan. The latter has spilled over to other Asian currencies. The Chinese central bank has allowed the yuan to depreciate to counter the effect of tariffs imposed by the US.
Hike in rates by the Reserve Bank
On the domestic front, core inflation continues to remain elevated and this may cause the RBI to change its policy stance to hawkish from neutral by the end of this year. Rate hikes would increase the borrowing costs for corporates and deter capex. Private consumption is also showing signs of slowing down.
Therefore, the onus to keep growth on track would be on government spending. The latter is likely to be higher than budgeted as we head into key state elections later this year and general elections in 2019. Higher government spending, coupled with consistent undershooting of monthly GST collections, poses risk of a fiscal slippage which may not be viewed favourably by investors, especially FPIs.
Political uncertainty ahead of the 2019 polls would also weigh on investors looking to infuse fresh capital into India. Dollar buying by importers to make payments after funding lines were restricted due to the the Punjab National Bank scam had also contributed to weakness in the rupee.