Rupee at 72 against US dollar: The Pain Might Not Be Over Yet, Says SBI
Moneylife Digital Team 06 September 2018
The Indian rupee on Thursday breached the 72 per US dollar mark for the first time. The depreciation in Indian rupee is largely in consonance with US dollar strengthening against all currencies. Since the Indian rupee could not have been immune to such pressure, the current depreciation was long overdue and trends in Non-deliverable forwards (NDF) market suggest the pain might not be just over yet, says a research report.
In the note, State Bank of India (SBI) says, "In the hindsight, the rupee depreciation of 13% in 2018 and around 7% since June 2018 when the RBI started hiking rates is largely in consonance with the US dollar strengthening against all currencies. We analysed the movement of rupee against dollar since global financial crisis period and it is quite visible from the data that depreciation was always followed by appreciation of currency. We believe this time will be no different as currency will start appreciating once the dust settles for the currency to settle at a lower level."
The Indian rupee has now depreciated by 7% from June 2018, when the Reserve Bank of India (RBI) started hiking rates and close to 13% in 2018. "Thus, by any stretch of imagination, the depreciation in rupee has now outpaced other Asian currencies like Indonesia. We believe, beyond a certain level of depreciation, the costs could outweigh benefits. There are many components of such cost," the report says.
The lender also shares an interesting anecdote on asymmetric behaviour on the part of portfolio investors in times of depreciation and appreciation. 
Foreign portfolio investment (FPI) generally responds negatively to domestic currency depreciation over a period. This is obvious, as typical portfolio investor brings in foreign currency but invests in domestic currency and, therefore, a depreciation in domestic currency will only mean that a portfolio investor will be able to take out a lower amount of foreign currency compared to what was originally invested. Thus, it will always be the endeavour of the portfolio investors to prefer a wait and watch policy in the event of a gradual depreciation of the domestic currency. Hence, portfolio investors have a typical asymmetric behaviour as they behave contrarily to appreciation and depreciation of the domestic currency, SBI says.
"Thus, it is likely that once the rupee settles at a lower level, portfolio investors now conspicuous by their absence will return in hordes and the rupee will appreciate. This is what history of Indian foreign exchange market says and sometimes the period of appreciating rupee following a depreciating rupee could be even higher! On a lighter note, this could make both camps happy," the report added. 
Talking down the rupee as was done recently when the markets were volatile might have been counterproductive and thus the pace of depreciation picked up frantic pace in the last week or so. In this context, SBI says, the statement by the finance minister is most welcome and timely one as it has provided an immediate succour to battered market sentiments. The RBI could also chip in with a message that could be most comforting under the current circumstances, it added.
According to SBI, the largest lender in the country, there are two perceived benefits of rupee depreciation in the form of increased exports and automatic adjustment of trade deficit in policy circles. However, it says, it believes the traditional view that weak exchange rates could dramatically boost exports growth is not entirely correct over the long term as India’s export basket has changed significantly from traditional products to more mechanized engineering goods over the years, thus making them more income elastic rather than price
Policymakers need to be mindful of the several costs of rupee depreciation, like short-term debt obligation, oil import bill, yields, effect on inflation and return of portfolio investors, the report says.
It says, "First, India’s short term debt obligations at $218 billion due on December 2018 if rolled over could add a significant cost on the Government. Second, oil import bill could go up manifold. Third, with yields increasing, this could add up government fiscal costs too. On all these counts the costs could add up to 0.7% of gross domestic product (GDP). It may be noted that the yields are already under pressure as unlike earlier years, the government borrowing programme has been evenly distributed between two halves in current fiscal."
"Fourth, as per RBI estimates, assuming a 10% depreciation, this could add upto 50 bps on inflation number. In fact, continued rupee depreciation could result in rate action by RBI in October policy, even as headline CPI will decline meaningfully to 3.6-3.7% in September. This could be thus the biggest predicament waiting to unravel," SBI says.
India’s short-term debt obligations as on December 2017 were about $217.6 billion. Assuming half of the amount either has been paid in first half of 2018 or is rolled over to 2019, the remaining repayment amount in rupee terms would be Rs7.1 lakh crore at average 2017 exchange rate of Rs65.1 per US dollar. For second half,  assuming that rupee depreciates to an average value of 71.4 per US dollar, the debt repayment amount would be Rs7.8 lakh crore, thereby implying an extra cost of Rs67,000 crore. 
Talking about oil import bill, SBI says, it assumes that the volume of India's crude oil imports would increase by a modest 3.6% (average of past five years) in 2018. 
"If we reduce the volume of oil imported in the first half of the current FY, the remaining volume of crude to be imported comes to 760 million barrels (bbl). At an average oil price of $74.24 per bbl for the remaining half, crude import bill of India in 2018 should amount to $57 billion. If the average exchange rate remained at Rs65.1 per US dollar, the crude oil import bill would have been Rs3.64 lakh crore. However, with rupee depreciating to an average of Rs71.4 per US dollar in second half of 2018 end, the import bill would increase to Rs4.03 lakh crore, implying an extra cost of around Rs35,300 crore. With crude oil averaging to $76 per bbl for the remaining half and average exchange rate at Rs73 per US dollar, the extra cost could go up to Rs45,700 crore ," the report says.

According to RBI of the Indian rupee by around 5% relative to the baseline, inflation could edge higher by around 20 basis points (bps). With rupee expected to depreciate by say around 14% this year, SBI feels that keeping everything else constant inflation could edge by 56 bps going by the RBI numbers.

According to SBI, if the rupee continues to depreciate, it may move RBI towards increasing the regulatory interest rates and it could pressurise RBI to go for more rate hikes. RBI’s successive rate hikes will have a negative impact on private final consumption expenditure (PFCE) as well as investment expenditure, thereby widening the output gap. For instance, during FY13-14, three successive rate hikes led to collapse of private consumption expenditure to 2.0% in Q3 FY14-15 from 8.6% growth in Q2 FY14-15. During Q1 FY18-19, PFCE increased by 8.6% (6-quarter high) and RBI has already hiked repo rate in two successive rate hikes. The continued rupee depreciation and given the significant costs of RBI intervention in forex market and hence the RBI apathy to take that route could result in at least one more hike, possibly frontloaded, the report added.
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