Indian Rupee hits record low against US Dollar: Factors that Affect dollar-rupee Relation
The Indian rupee (INR) fell to its lowest closing level ever against the dollar on Thursday, Aug 17, 2023. The rupee ended at 83.14 against the U.S. dollar. This depreciation is attributed to several factors, such as the US treasury yields at a lifetime high, a strong US Dollar Index, and a global risk-averse environment.
Reasons for Rupee depreciating to record low:
- US-Treasury yield at lifetime high
U.S. Treasury yields rose after the US central bank stated that most policymakers feel that inflation risks could require further interest rate hikes, negatively affecting the value of the rupee. When U.S. Treasury yields rise, U.S. debt bonds become more attractive to investors, leading to increased demand for the U.S. dollar. This capital flow into dollar-denominated assets typically results in reduced demand for emerging market currencies, including the Indian Rupee, causing them to depreciate. Additionally, higher U.S. yields can signal expectations of tighter U.S. monetary policy, which further strengthens the U.S. dollar and can lead to capital outflows from emerging markets like India, exerting downward pressure on the Rupee.
- The dollar index gained
The Dollar Index, often denoted is a measure of the value of the United States Dollar relative to a basket of foreign currencies. The basket includes the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona, and Swiss Franc. The U.S. dollar index was 0.097% higher on Aug 17, 2023, at 103.56. This was supported by a recent run of U.S. economic data reinforcing the view that interest rates will remain high for some time. Further, indicating a strong outlook for the US economy and a weaker Indian rupee.
- Weakness in the yuan
China's yuan fell to the weakest level due to a series of disappointing economic figures which led to concerns about the nation's economic growth. Yuan dropped as much as 0.5% Monday, Aug 14, 2023, to 7.2927 per dollar. A weakening Chinese Yuan affects export-import dynamics, it makes Chinese exports cheaper, potentially boosting their competitiveness globally. Whereas, it erodes profit margins for exporters in India as their exports will be less competitive in comparison. This leads to a negative trade balance and a fall in the rupee.
- Risk-averse environment weighed on global economy currencies
In a risk-averse economy, investors seek safety, often moving capital to stable assets and currencies, like the U.S. dollar or Swiss franc. This can lead to an appreciation of these "safe haven" currencies and the depreciation of perceived riskier currencies such as the INR in this case. Now, a risk-averse environment is driven by multiple factors such as inflation worries, high interest rates, job losses, less of consumer spending and recession fears all of which are interlinked and lead to a weaker local currency.
These factors brought the rupee to record low levels which has prompted the Reserve Bank of India (RBI) to intervene in the foreign exchange market to curb volatility. This seemed to have shielded the rupee from further weakness.
Now, how does RBI bring down the foreign exchange rate?
- The RBI can intervene in the foreign exchange market by buying or selling its own currency. If the exchange rate is too high, the RBI can sell its own currency to increase the supply of the currency in the market.
- This can bring down the exchange rate and make exports more competitive. Whereas, as per the current state of the foreign exchange being at a record low, RBI intervened by buying its own currency i.e., INR to increase the foreign exchange rate. This, however, will make exports less competitive and affect the international trade balance negatively.
Factors that an investor needs to consider while investing in the rupee:
- US Dollar Index and US treasury yields
A strong US Dollar Index will increase the movement of capital out of emerging economies like India and put pressure on the local currency (INR), raising the price of imports and making them less competitive, resulting in a depreciation of INR.
- US interest rates
When the US Fed increases interest rates, RBI also has to increase interest rates here in India so that the outflows of funds from the FIIs (Foreign Institutional Investors) can be curtailed to safeguard the rupee. Therefore, the foreign investors will be tempted to withdraw from the Indian market and invest in US assets, as the Dollar and the US Treasury yield become more attractive in the US and the Indian market begins to see capital outflow. This makes the rupee weaker and it prompts RBI for a rate hike in India. If the rupee falls significantly, the RBI may be forced to sell some dollars to help shore up the domestic currency. This depletes the domestic Forex reserve.
- Inflation Pressures
High inflation exerts a notable downward pressure on a country's currency value. India’s retail inflation, which is measured by the consumer price index (CPI), rose to a 15-month high of 7.44% in July 2023, from 4.81% in June this year. Escalating inflation erodes the currency's purchasing power, diminishing investor confidence and international attractiveness. In response, foreign investors may divert funds to more stable economies, weakening Rupee further.
- Oil Prices
Crude oil and other commodities cost more when the Rupee decreases in value. As a result, import prices rise and India's current account is in deficit. Additionally, it has a negative impact on oil refineries, oil importers, and oil firms' bottom lines too.
- Current account deficit (imports - exports)
When a country's imports exceed its exports, it results in a net outflow of money, which can lead to a decrease in demand for the country's currency. This decrease in demand for the currency can cause its value to weaken or depreciate. In other words, India’s current account deficit is shrinking, which means that exports are more than imports, leading to a favorable trade balance and strengthening the rupee.
- Central bank reserves - RBI
The RBI also intervenes in the foreign currency market to strengthen the Rupee. This can entail purchasing or selling foreign money to affect the Rupee's value.
- FII investments
International investors in India have the chance to earn lesser returns on their investments with a weaker Rupee. FPIs/FIIs flow out of the Indian economy and their contribution to economic growth may suffer.
This is not investment advice. Investments in the securities market are subject to market risk, read all the related documents carefully before investing. Past performance is not indicative of future returns.