This Article is From May 09, 2022

Rupee Hitting New All-Time Low Signals More Forex Reserve Erosion

The rupee weakened to an all-time low suggesting India's forex reserves, which fell below $600 billion to their lowest in a year, will erode further.

Rupee Hitting New All-Time Low Signals More Forex Reserve Erosion

Rupee hitting an all-time low will push forex reserves to fall further

The rupee weakened to an all-time low on Monday, trading beyond 77.40 against the dollar, suggesting India's foreign (forex or FX) exchange reserves, which fell below $600 billion to their lowest in a year, will likely erode further.

As per the latest data for the April 29 ending week from the Reserve Bank of India on Friday, the country's FX reserves fell by $2.695 billion to $597.728 billion, marking the eighth straight week of declines, largely after Russia attacked Ukraine late in February.

Indeed, according to the RBI's weekly statistical supplement data, India's FX war chest is down about 5.4 per cent, or nearly $34 billion, since the February 25 week data.

For India to build its FX reserves to above $630 billion, it took almost a year, but the global energy crisis from the Ukraine war has hurt the country's currency and its import cover in just over two months.

The fall in India's import cover for eight consecutive weeks started in the week ending March 11, when the rupee hit its previous all-time low of 77.05 per dollar. During this period, India also witnessed its steepest weekly dip in FX reserves on record - by nearly $12 billion in the week that ended on April 1.

That slump below $600 billion was the first time since late May 2021 and the lowest since end-April last year, when the country was battling its worst wave of the coronavirus pandemic.

And if that is anything to go by, then the rupee falling to a fresh record low paints an ominous sign for the country's import cover during these uncertain times.

The rupee slump is driven by the dollar's surge to over two-decade highs on aggressive US Federal Reserve posturing to combat runaway inflation - a fallout of the Ukraine war on supply disruptions.

With the US Fed poised to hike aggressively in the coming year, the dollar reign is expected to continue weighing other currencies, especially the emerging market ones and their FX reserves.

That despite an off-cycle rate increase by the RBI last week, suggesting the interest rate differential dynamic, surging inflation from higher commodity prices and elevated crude oil prices would force India's central bank to keep selling dollars to prevent a slide in the value of the rupee.

The persistent capital outflows have not helped the rupee, which has also weighed heavily on India's import war chest.

Indeed, foreign investors have pulled out over Rs 6,400 crore from the Indian equity market in May's first four trading sessions, after remaining net sellers for seven months to April 2022, withdrawing over Rs 1.65 lakh crore from equities.

A separate report by the Wall Street brokerage, Bank of America Securities India, showed that foreign funds' ownership in domestic equities fell to pre-COVID-19 lows and hit a multi-year low of 19.5 per cent in March this year NSE500 companies.

Significantly, the share loss of foreign portfolio investors (FPIs) has been well covered by steeply rising ownership of stocks by domestic funds, who pumped in $6 billion in March and $14.6 billion in 2021-22, the report said.

While domestic retail investors have covered foreign investors' exodus, it does not help the rupee or the forex reserves equation.

While currency weakness typically benefits exports, the equation may not hold when inflation is high and rising, which is the current global scenario.

The double whammy from the rupee weakening and crude surging and averaging to above $100 per barrel since late February has weighed on India because it depends on imports for 85 per cent of its oil needs.

The rule of thumb is that a firmer greenback makes dollar-denominated commodities costlier for consumers who use other currencies, eventually subduing demand and prices.

But the energy crisis from the Russia-Ukraine crisis has not abated, and India's import bill will widen further on a weakening rupee and elevated oil prices.

What started as the worst-case scenario of widening external balances, imported inflation, and higher interest rates has quickly turned into a base case for India.