The rupee is flirting with lifetime lows against the dollar as risk-wary investors favour the greenback over the Indian economy, which is beset by sharply slower growth, worsening public finances and political turmoil.
The so-called “India story” has faded with the shortfall in the current account — the broadest trade measure — ballooning to just under 5% of gross domestic product in the last financial year from 4.2% the previous year, and growth at a decade-low of 5%, say analysts.
“I don’t see anything that can turn the rupee around for a while,” Mitul Kotecha, Credit Agricole global foreign exchange strategy chief, said. “The currency is generally suffering from higher risk aversion which has sent people into US assets and a slew of domestic concerns like politics.”
The currency, Asia’s worst performer in May after falling 5%, was trading at 56.66 against the dollar on Tuesday — less than a rupee above its all-time low of Rs 57.32 reached last June.
The currency’s woes all add up to bad news for the Congress-led UPA government led by Prime Minister Manmohan Singh, which is struggling to rein in subsidies and overspending under pressure from international ratings agencies.
The weaker rupee makes imports costlier, especially of foreign oil on which India relies on heavily, and will stoke already high consumer inflation.
The country is now heavily reliant on fickle portfolio inflows — foreign purchases of shares and bonds — to cover its current account gap.
Particularly worrying are figures showing a 38% drop in foreign direct investment (FDI) — seen as long-term investment in infrastructure and other projects — as overseas investors have given India a wide berth.
Meanwhile, foreign institutional investors or FIIs last year chasing short-term returns poured a record $26 billion into Indian shares and bonds markets.
This makes India vulnerable to a balance of payments crisis in the event of a new financial crisis or conversely an economic recovery in which better returns are offered in the developed world and investors repatriate their capital.
The rupee could face “an unpleasant shock”, noted CLSA economist Rajeev Malik, adding that India “appeared to be ill-prepared” for a reversal in fund flows.
Memories are still sharp of India’s humiliating 1991 balance of payments crisis when it rapidly depleted its reserves, resulting in a currency devaluation.
Singh’s administration is battling a host of graft scandals that have stalled politically contentious steps to spur domestic demand before elections due by May 2014.
“It’s going to be tough to get much done (legislatively) with the elections coming,” said Kotecha.
The central bank has maintained a “hands-off” approach toward the currency with the Reserve Bank of India’s chief saying this week that he was not targeting any particular level.
Analysts say the bank can not intervene heavily to buttress the currency as it must retain enough foreign reserves pay for imports. Right now, it only has sufficient reserves for seven months of imports — the lowest cover in 13 years.
Some analysts expect the currency to fall to Rs 57 to Rs 58 to the dollar by year-end and to Rs 60 in the first-half of 2014.
With traders expecting more cuts in rates to spur the economy, possibly at the central bank’s June 17 meeting, the currently is facing relentless pressure as lower rates usually translate into a weaker exchange rate.
Deepak Lalwani, a London-based investment analyst, blames the soft rupee on “the economy’s sharp slowdown, fiscal indiscipline, high inflation which has led to high interest rates and hurt consumer demand, graft scandals and policy gridlock”.