Decoding why the rupee has touched an all-time low of 57

The rupee slide continued against the dollar and hit a new record low of 56.70  today on as oil importing companies’ demand for dollars and and gold importers, as well the broad risk-off sentiment.

Globally investors are fleeing risky assets fearing a growth slowdown. “The broad risk aversion is hurting. There were bids from oil firms as oil prices are also lower while goldies also bought,” said Vikas Babu Chittiprolu, a forex dealer with Andhra Bank.

Oil companies are the largest buyers of dollars in the domestic currency market as India imports nearly two-thirds of its oil needs. Brent crude was hovering around $90 a barrel, up slightly from an 18-month low hit on Thursday.

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Traders have not spot intervention from the Reserve Bank of India so far, but most expect the central bank to step up dollar sales if the rupee crosses the 57 mark.

The RBI was suspected to have sold dollars on Thursday, though the actions were described by traders as “mild.”

“The USD is strong across the board. I think at the higher levels exporters are unwinding their positions partially,”  Uday Bhatt, a forex dealer with state-run UCO Bank told Reuters.

The partially convertible rupee was at 56.96/97 per dollar, after hitting a record low of 56.97, and down nearly 1.2 percent from its Thursday’s close of 56.30/31.

The past couple of sessions have resembled developments in May, when the rupee tumbled to a string of record lows, as renewed global risk aversion exposed India’s fiscal and economic challenges.

But why is the currency jumping off a cliff right now? To be sure, nothing has really changed in the past few weeks for the rupee to take such a deep dive. The usual reasons cited — India’s high current account deficit, high fiscal deficit, slowing economy, rising inflation— are facts we’ve been aware of for some time now. Fears of Greece also can’t explain why the currency has been one of the worst performing ones in the Asian region.

Indeed, if we were to assume that the Indian economy’s shaky fundamentals are to blame for the rupee’s troubles, how is it that the US dollar, which has an even shakier economy behind it, is gaining against several major currencies?

Consider these facts: The sluggish US economy is expected to grow just a little over 2 percent in 2012. However, in the absence of Congress action, automatic spending cuts and the end of Bush-era tax cuts in 2013 could tip the economy back into recession, according to some experts.

The government is also far from putting its fiscal house in order. Its outstanding public debt currently is just slightly above 100 percent of GDP, while its federal deficit (the gap between government revenues and expenditure) for fiscal 2012 totalled $1.2 trillion — equivalent to 8.7 percent of GDP.

Its current account deficit — the combined balances on trade in goods and services, income and net unilateral current transfers  – hit $473 billion in 2011, equivalent to 3.2 percent of GDP.

In comparison, India’s GDP is expected to grow by around 6-6.5 percent, while its public debt -to-GDP ratio was a far lower 66 percent in 2010-2011. The combined fiscal deficit (states and Centre) has also remained around 8-9 percent over the past few years.

Given that India’s economic metrics are relatively better than those of the US, why is the dollar galloping against the rupee?

Simple. The greenback continues to be perceived as a safe haven. The only safe haven, in fact, for investors right now in the currently highly troubled economic environment. The other traditional safe haven, gold, has fallen 12 percent since February.

Given the deepening eurozone crisis, there’s growing speculation about what the future of the Europe’s common currency will be. And that has led investors to dump ‘riskier’ emerging market assets in favour of safe havens like the dollar.

That’s strange, really. Because it’s possible to argue that the economic risks are currently much higher in the developed world. In fact, the two biggest risks to the global economy over the past five years — the credit crisis of 2008 and the ongoing eurozone sovereign debt crisis — have both sprung from developed economies.

The only thing that really shows the US economy in far better light that India’s is its dynamic pro-business environment. Maybe, this is what the Indian government needs to fix.

Even so, while there are a host of reasons that can justify the rupee’s gradual decline, there are none to justify a 7 percent fall in one month. Given that financial markets have a tendency to overshoot when they move either up or down, it’s likely the rupee’s recent correction is a bit overdone. Is it time for a rebound?

By Firstpost Editors, Firstpost.com
With inputs from Reuters