Rupee rout on the indian currency's slide

Rupee rout on the indian currency's slide

Slide of the currency and a widening trade deficit present the RBI with a huge dilemma.

India’s macroeconomic threats lie exposed as it grapples with the rupee’s slide. The currency sunk to a closing low of 68.07 against the U.S. dollar on Tuesday, its lowest level in 16 months, before recovering slightly the next day. The rupee, already one of the worst performing Asian currencies, has now weakened 6.2% in 2018. The rise in crude oil prices through this year, amidst rising geopolitical tensions in West Asia and dwindling global supply, have obviously hurt the rupee and the trade balance. Meanwhile, despite a depreciating currency, India’s merchandise exports are stumbling instead of gaining from the opportunity. April clocked a sharp decline in exports from employment-intensive sectors such as readymade garments and gems and jewellery, according to official data. The trade deficit has consequently widened to $13.7 billion in April, compared to $13.25 billion in the same month in 2017. The value of oil and petroleum product imports increased by 41.5% from last year to hit $10.4 billion. U.S. sanctions following Washington’s withdrawal from the Iran nuclear deal and a June 22 meeting of OPEC should drive oil price trends hereon. Oil prices apart, the tightening of U.S. monetary policy has almost always spelled trouble for emerging market economies hooked to Western capital inflows. This time it is no different; capital outflows are scuppering the currencies of many emerging market economies.

As the U.S. Federal Reserve has come to adopt a more hawkish stance, investors in search of higher risk-adjusted yields have started to pull money out of emerging markets. Yields on emerging market bonds have risen as investors sold them off aggressively. The yield on the 10-year bond issued by the Indian government has risen to more than 7.8%, from 7.1% in early April. Foreign portfolio investors (FPIs) pulled out ₹15,500 crore from India’s capital markets in April, which is the highest monthly outflow since December 2016. Not surprisingly, about two-thirds of the outflow was attributed to the bond market. The current headwinds from the reversal of capital flows were only to be expected. India is better placed than countries such as Argentina or Turkey. But that’s no reason to be complacent as external account risks can get out of hand very quickly. A hike in the RBI’s benchmark interest rates could stem the capital exodus, but with core inflation picking up and the government keen on a rate cut as a growth catalyst, the RBI has an unenviable dilemma on its hands. Policymakers, blessed with relatively benign external economic conditions after the taper tantrum of 2013, will have to find means to spur exports — whether by facilitating swifter GST refunds or taking on tariff and non-tariff barriers from the developed world. Efforts to diversify India’s energy basket also need greater stress.