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The Flip-flop In The Rupee

The Indian rupee may weaken further as foreign investors pull out precious dollars from Indian shores

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The rupee has breached the safety zone. Just when everybody thought that the macro-economic fundamentals of the country were stable, the Indian currency breached the psychological Rs 68 to the dollar. It is now hovering at Rs 68.55 — and threatening to slip further. And, if global currency dynamics are to be blamed, it might slide to its lowest level of Rs 69.80. Or, even plunge past the Rs 70 mark in coming months.

Donald Trump is likely to increase spending and cut taxes to boost the US economy. This would expand fiscal deficit and stoke inflation — all signs that US interest rates are heading in one direction — northward.

As a result, dollars are being rapidly hauled into the US from many emerging markets. India, being no exception, is caught in the global rollback. In the last few weeks foreign investors have withdrawn nearly $3 billion from Indian equity and debt markets. There could be further pullouts till the US Fed policy is announced next month.

Soumyajit Niyogi, associate director, Credit & Market Research, India Ratings & Research says: “After the US elections, US yields have surged to 2.3 per cent. In the last few weeks the spread between domestic and US interest rates have dropped. After factoring in hedging costs, the spreads are too slim, or negligible, for foreign investors to benefit.”

Many emerging-market currencies have been on a losing stretch since Trump’s election. Brazil’s real dropped 6.6 per cent, the South African rand 8.33 per cent, Turkey’s lira 6.68 per cent, and the South Korean won 4.1 percent.

In comparison, the Indian rupee has lost merely 2.64 per cent in the same period. “The rupee is showing resilience because Indian macros are strong,” points out Niyogi. “The strengthening dollar is the chief cause of the weakness. If foreign investors continue to withdraw from Indian markets, the rupee could weaken further.”

The rupee’s weakness is also being adduced to the concern that the demonetisation is likely compress India’s GDP and squeeze corporate profitability. Niyogi reckons it’s probably one of lesser reasons driving foreign investors away from Indian shores. “Demoneti-sation has not had much of an impact on the rupee; it’s only to the extent that it has seen a pullout from equity markets.”

Will India make up for the drop through swelling exports? Not really. “Export growth is slow, and a sluggish global economy is not really helping,” states Niyogi. The rupee could recover some of its losses if the dollar weakens, particularly if the US economy does not see a smooth take-off on Trump’s boastful runway. For now, though, that’s little or no comfort.