Rupee falters to 78.40/$ as strong dollar hurts

It is no secret that the rupee has been falling and it has been falling consistently; or rather you can say it is weakening. On Wednesday 22nd June, the Indian rupee slumped to a fresh life-time low of 78.39/$ as risk appetite diminished ahead of the Jerome Powell testimony to the US Senate. There are other reasons too like the oil price spike and the consistent FPI outflows. But, for now, it is the dollar strength that is making all the difference and putting immense pressure on the Indian rupee.

Foreign portfolio investors (FPIs) have sold equities worth Rs.45,000 crore in the month of June till date. This comes on top of Rs.220,000 crore of equity selling already seen between October 2021 and May 2022. Now, the FPIs are also exiting India as the fear of a global recession is pushing these investors to safer havens. This includes markets like the US and continental Europe as well as asset classes like debt and gold. Both these trends are negative for equity flows. Weak liquidity is also hitting passive flow liquidity.

One of the main reason for the fall in the rupee is that traders are virtually shunning emerging market currency, leading to a run on these currencies. That largely explains why the rupee slipped 31 paise to Rs.78.39/$. The US Fed is planning another 75 basis point rate hike and that is likely to raise interest rates further and make the dollar stronger. In fact, more than the weakness in the rupee, it is the strength of the dollar that is really spooking the Indian rupee. Powell’s comments also put the focus back on front ending rate hikes.
 

A classic gauge of the dollar strength is the Bloomberg Dollar Index (DXY). This index is currently hovering at 104.95 and had recently touched a 20-year high of 105.65. That level could easily get breached if the Fed is going to continue on its rate hike pathway. A spike in the rates makes dollar assets more attractive so more funds flow into the US. This strengthens the US dollar and that is reflected in the DXY. Once the DXY strengthens, the impact is immediately felt on the USD INR exchange rate as it starts weakening.

There is also a practical reason. There has been consistent purchase of US dollars by state-owned banks. This is most likely on behalf of oil marketing companies, which have huge dollar players, which his only partially hedged. Normally, the domestic borrowers and importers are covered up to Rs.80/dollar. As the rupee approaches that level, most of the people are likely to panic and rush for cover. That, in itself, would create a lot of volatility and weaken the rupee further.

Of course, there is no need to emphasise that the surge in crude oil prices since the Ukraine war started also is a major concern for India. For India, this results in a widening of the trade deficit and also the current account deficit, which is normally a key factor that determines the exchange rate. In addition, the higher interest rates in the US also reduce the appeal of riskier emerging-market assets. So, it is hitting both ways; in that policy rates are moving higher, while the domestic currency is on a weak glide path.
 

What about RBI intervention?

RBI had briefly intervened around the 78/$ level but apparently has given up against the pressure of dollar buying. Now the next level that the RBI may look at is the psychological level of 80/$. For now, the focus of the RBI is more at preventing excess volatility, than stemming the rupee depreciation. After all, a weak rupee is in the interests of exporters. Most experts are already projecting levels of 80/$ for the rupee and perhaps even beyond that. However, RBI repo hikes will salvage the situation.