Rupee's hitting record lows; Key reasons explained

The Indian Rupee has been making headlines every day in recent weeks as it reaches new lows. On Wednesday, it reached another record low of 81.93 against the US dollar for fifth day in a row. 

On Tuesday, the Indian Rupee fell to a record low of 81.77 against the dollar

Following the US Fed's rate hike last week, the rupee fell 2.25%. So far this year, the Indian currency has lost 9.70% of its value against the US dollar, and since the start of the first rate hike from the US Fed on March 22, the rupee has fallen by 7.10%.

On September 21, the US Fed delivered a third straight three-quarter point increase, pushing borrowing costs to the highest level since 2008 and signalling that they will keep rising well above the current level as it intends to restore inflation to the 2% target level. Year to date, the US Fed has delivered five consecutive rate hikes, bringing the Federal funds rate to 3%-3.25% of the way from zero.

Following the rate hike from the Fed, the dollar index gained by 3.5%. On Monday, the dollar index hit a fresh 20-year high of 114.58 on expectations that the Fed would tighten monetary settings further to stamp out surging Inflation.

Besides Rupee there are other major currencies, including the pound, euro, and Australian dollar, that have fallen by 8 to 20 percent against the dollar so far this year. On Monday, the British pound plunged to a record low of $1.0382 following the announcement by the new U.K government that it would implement tax cuts and investment to boost growth. Investors are concerned about a massive tax cut package that is expected to cost tens of billions of pounds in additional government borrowing and amounts to a risky gamble to avert a looming recession.

Just after the pound's depreciation, the Bank of England stated that it will not hesitate to change interest rates as needed to sustainably return inflation to the 2% target in the medium term, according to media reports. 

Meanwhile, the Australian dollar depreciated to around $0.65, the lowest level since May 2020. The Japanese yen, on the other hand, weakened to 144 per dollar and is heading towards its lowest level in 24 years, prompting authorities to issue fresh warnings against sharp yen declines just days after the government intervened in the currency markets for the first time since 1998 to stem yen falls, according to Trading Economics.

The Euro, the official currency of 19 member countries of the eurozone, is still trading below the parity level of (1.0000) against the dollar. For the first time in nearly 20 years in July, the euro reached parity against the USD. The last time it happened was in November 2002, when the euro was worth $0.99.

Back home in India, the RBI is taking every possible step to defend the rupee, and as a result, India's foreign reserves are depleting faster. According to a report by Reuters, the RBI is using its foreign exchange reserves at a quicker pace than during the taper-tantrum period in 2013, as it tries to prevent an overshoot in the rupee.

The Reserve Bank of India has sold a net of $38.8 billion of its forex reserves between January and July this year, the report showed, quoting RBI data.

In 2013, the RBI sold a net of $14 billion in the June-to-September period after the so-called taper tantrum-when U.S. Treasury yields spiked after the Federal Reserve said it would slow its pace of bond buybacks-had put pressure on emerging economy currencies, including the rupee.

Further, the Indian forex reserves have fallen to a 2-year low of $545 billion from a peak of $642 billion in October 2021, the report said. The decline in foreign reserves and a pick-up in imports has meant that this pool is now adequate to cover about nine months of imports, compared to 16 months at the peak.

During the time of the taper tantrum, India's forex reserves-to-imports cover had fallen to below seven months, according to Reuters.

Meanwhile, the economists from SBI, UBS, Goldman Sachs, Barclays, and Bank of Baroda are forecasting that the RBI will deliver a 50 bps in the upcoming RBI's MPC bi-monthly monetary policy scheduled on September 30. The Reserve Bank of India has raised interest rates by 140 basis points this year, to 5.40 percent.

Below are some of the other key factors which are currently dragging the Indian rupee to an all-time low.

Rate hikes by Major Central Banks

FIIs invest in Indian stocks or other emerging markets when they have excess liquidity (low borrowing costs). When US bonds pay close to 0% interest, foreign investors look for better investments all around the world. If emerging countries like India offer interest rates close to 6-7 percent, some of the surplus liquidity will move to Indian stocks, which in turn will strengthen the rupee.

The rise in capital flows will also support the financing of the current account deficit and also contribute to the accretion of the official reserves. At present, interest rates are moving higher, and with growing recession fears, most of the capital flows are moving back from emerging markets, including India, which is affecting the rupee badly.

Further, during the second rate hike, the US Fed announced the shift to Quantitative Tightening from Quantitative Easing.

Widening Trade Deficit

India's trade deficit in August widened to $27.98 billion from $11.71 billion in the same month of last year. Sequentially, it has moderated from a record high of $30 billion in July. In August, exports fell to $33 billion, from $40.1 billion and $36.3 billion registered in June and July, respectively.

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.

As the trade deficit keeps expanding month after month, pressure is put on the rupee since many dollars are going out than coming in. This causes the rupee to weaken or depreciate while strengthening the dollar.

As exports dip, Standard Chartered raised its estimate of India's current account deficit forecast for the fiscal year ending March 2023 to 3.8% of India's GDP from its earlier estimate of 3.0%, which is a higher projection than peers Morgan Stanley, Goldman Sachs, and Nomura.

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