Global currency markets are in turmoil; What happens now?

In any economy, an individual cannot manufacture all the items he desires, such as shoes or clothing; he must rely on others. Similarly, a country cannot generate all the commodities required by its population, it must depend on other nations for crude oil, gold, and manufacturing and to pay for these imports countries require dollars in reserves as it is the world's reserve currency. To facilitate global trade, major currencies are pegged to the dollar. The strength of the Dollar is determined by interest rates: if the US Fed raises rates, the dollar strengthens; if it lowers rates, the dollar weakens.

The US Federal Reserve recently lifted its benchmark rate by 0.75 percentage point, the greatest increase since 1994, after the country's inflation reached multi-decade highs. The Fed's rate hikes cause yields on US Treasury bonds to climb, attracting investors seeking higher yields than they can find elsewhere in the world. This increased demand for dollar-denominated securities, in turn, boosts the dollar's value. 

The dollar index, which measures the greenback against six major currencies, is up 12% against a basket of peers in 2022, currently, it is trading around 107.2, hovering near its highest level in 20 years, data by Trading Economics shows.

At present Currencies around the world were being pushed down by the dollar as countries sought to combat inflation by raising interest rates at the risk of entering a recession.

Major global currencies such as the Euro, Pound, Yen, Australian Dollar, Swiss Franc, and New Zealand Dollar have fallen between 8 and 17 percent this year, according to Trading Economics data.

On Wednesday, the Euro fell to $1.01615, its lowest level in 20 years, and is on the verge of reaching dollar parity amid growing fears that Russia will cut off gas supplies to Europe, plunging the region into recession. The annual inflation rate in the Euro Area increased to a new record high of 8.6% in June of 2022.

The British pound has been one of the worst-performing currencies against the US dollar this year. The pound has dropped 12% against the dollar so far this year. The United Kingdom’s consumer price inflation hit a 40-year high of 9.1 per cent last month on the back of rising food prices. 

The commodity-linked currency, the Australian dollar, rose 0.7% to 0.6822 against the U.S. dollar after recently hitting its lowest since May 2020 at 0.6762. The Japanese yen held above 135 per dollar, hovering near its lowest level in 24 years. According to Trading Economics, the Bank of Japan remains the only major central bank that has maintained ultra-easy policies at a time when other major economies are racing ahead with interest rate hikes to combat surging inflation.

Meanwhile, the MSCI Emerging Markets Currency Index dropped for a second day on Wednesday, extending this year’s slide to 4.5%, the biggest for such a period ever. Losses in the developing world were led by the Russian ruble, which fell for a fourth day amid talks about foreign-exchange intervention. The Colombian peso dropped to a fresh record against the dollar. 

The Philippine peso led declines in Asian trade, sliding to the lowest level in 17 years, while the South Korean won tumbled to its weakest since 2009, and inflation in the country accelerated at the fastest pace since November 1998. The country's inflation rate was also above the central bank's 2% target for the 15th consecutive month. Further, the Indian rupee has depreciated 6% against the dollar this year. After the Philippine peso and the Thai baht, the Rupee was the third-worst performing Asian currency, reported by Bloomberg.

Wider CAD may put more pressure on Rupee

India’s trade deficit in June widened to a record $25.63 billion as compared with $9.61 billion in June 2021, according to the government’s preliminary data. The country’s merchandise exports jumped 16.78 per cent year-on-year to $37.94 billion in June, while imports increased 51 per cent year-on-year to $63.58 billion.

Global crude oil and commodity prices have risen since the start of the Russian-Ukraine war, and the shortage of coal domestically has pushed more coal imports.

If the current account deficit rises further, it will lead to more dollar outflows and put more pressure on the rupee at a time when foreign investors are selling in Indian equity markets. The Indian rupee touched a record low of 79.37 against the dollar on Tuesday.

Meanwhile, foreign portfolio investors (FPIs) have now pulled out around ₹2.2 lakh crore from domestic equities in the first six months of 2022—the highest-ever net withdrawal by them. Before that, FPIs withdrew ₹52,987 crore in the entire 2008, data with depositories showed.

The Indian government has raised import duty on gold amid a widening trade deficit. The Centre has raised the basic import duty on gold from 7.5 per cent to 12.5 per cent, effective July 1st 2022, as per ET.

RBI Measures to stop Rupee free fall

The RBI took a few steps to increase foreign exchange inflows in the face of a massive dollar shortage. As per media reports.

Among the fresh steps, the cap has been removed on the interest rate that lenders can offer on foreign deposits by NRIs. The relaxation will be in force till October.

RBI has increased the External Commercial Borrowing (ECB) limit under the automatic route from USD 750 million or its equivalent per financial year to USD 1.5 billion and eased the norms for FPI investments in the debt market.

The all-in-cost ceiling under the ECB framework is also being raised by 100 basis points, subject to the borrower being of an investment-grade rating. The above dispensations are available up to December 31, 2022, as per the statement.

Further, the central bank has permitted banks to raise fresh FCNR(B) and NRE deposits without reference to the extant regulations on interest rates, with effect from July 7 till October 31, 2022.

Banks have also been given exemption from Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) on incremental FCNR(B) and NRE Term Deposits.

The central bank also announced major changes to attract Foreign Portfolio Investors (FPIs) investments in government securities and corporate bonds.

It has now been decided that all new issuances of G-Secs of 7-year and 14-year tenors, including the current issuances of 7.10 per cent GS 2029 and 7.54 per cent GS 2036, will be designated as specified securities under the Fully Accessible Route (FAR), the RBI said.

Another relaxation is with respect to the macro-prudential short-term limit norms for FPI investment in government securities and corporate debt till October 31 under the Medium-Term Framework (MTF) introduced in October 2015.

Meanwhile, the annual inflation rate in India edged down to 7.04 per cent in May of 2022 from an 8-year high of 7.79 per cent in April. However, it remained above the RBI's target range of 2%-6% for the 5th straight month

Govt is confident of meeting fiscal deficit target

A weakening currency damages the government's fiscal deficit number as it raises subsidy costs for the government. For instance, the Indian domestic fertiliser industry is largely dependent on imports to meet its raw material requirements for both urea and finished fertilisers. The government provides a subsidy on urea. So, if the value of urea imports increases, the subsidy burden on the government will rise too, which in turn hurts fiscal deficit numbers and may lead to additional borrowings.

However, with the rupee hitting an all-time low, the government is sure of meeting its fiscal deficit target even after the cut in the excise duty of ₹8 per litre on petrol and ₹6 a litre on diesel, which is estimated to have reduced its revenues by ₹1 lakh crore. Further, the government also announced an additional fertiliser subsidy of ₹1.10 lakh crore to further cushion farmers from the price rise. 

With the recent announcement of a windfall tax on fuel exports and a hike in the import duty on gold, the government has partially offset some of the revenue loss from fuel tax cuts.

On July 1, the government imposed windfall gain taxes on the export of petrol, diesel, and aviation turbine fuel (ATF) and on the domestic production of crude oil.

According to Moody's, the windfall taxes on domestic crude oil production and fuel exports will generate close to USD 12 billion ( ₹94,800 crore) for the government in the remainder of the current fiscal. 

Further, As per ET, public sector banks paid a record Rs. 7,867 crore dividends to the government this year, an indication of better profitability and capital position, largely driven by the falling stock of non-performing assets (NPAs). 

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