The Indian rupee has been under severe downward pressure ever since Russian tanks rolled into Ukraine on February 24. The currency has since lost to the US dollar on most trading days, touching a record low of 76.96 against the dollar on Monday.
Market analysts expect the rupee to undergo wild swings in the coming weeks if the Ukraine crisis is not resolved soon, with some ringing alarms it may breach the psychological 80 mark if current trends hold.
One of the main reasons for the rupee’s free fall has been the mass withdrawal by foreign portfolio investors and institutional investors in the Indian market. The Russia-Ukraine war has induced a sense of nervousness among investors, with many opting for safe-haven assets in developed markets.
Anticipated interest rate hikes by the US Federal Reserve is another factor. Federal Reserve Chairman Jerome Powell told the US Congress recently that the Fed plans to raise its key interest rate this month to fight a historic surge in inflation. This is despite the Ukraine crisis and its inflationary effects, including on the price of oil.
The rupee’s depreciation poses a challenge for the Indian government. While exporters will gain from the cost competitiveness of a depreciated currency, importers will feel the purchasing power pinch.
India imports nearly three-fourths of its oil, significantly at a time crude prices on global markets are skyrocketing towards $130 per barrel. The double whammy of a falling rupee and rising oil prices will inflate the national import bill and in turn the trade deficit, analysts warn.
According to Commerce Ministry data, India’s trade deficit in February widened to $21.19 billion from $13.2 billion in the same period last year.
A rise in gas and diesel prices will increase transportation costs and indirectly lead to a rise in the price of goods. Broad inflation is thus likely to go up and the central bank will find it difficult to maintain interest rates at a record low for much longer.
India’s central bank has retained the repo rate – the rate at which it lends funds to banks – at 4% since February 2020.
The ongoing depreciation of the rupee is also set to make borrowings in foreign currency more expensive for India Inc at the same time companies feel the pinch of rising commodity prices and a falling rupee.