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Rupee hits 65.5 against dollar; market braces for higher inflation

Indian currency continued its downward slide and hit a new record low of 65.5 against US dollar, piling up pressure on the country’s already burgeoning current account deficit and spiral effects on general inflation as imported cost of fuel rises.

The currency dropped to a new low of 65.5 against the dollar on Thursday morning, much lower than its closing mark of 64.1 on Wednesday.

The fresh slide in the currency followed disclosure of the minutes of a previous meeting of the US Fed on Wednesday which kept the market guessing on the timing of its rollback of monetary stimulus. Quantitative easing over the recent past had added to flow of US dollar propping up global markets but an impending reversal in policy has led investors to start pulling out of emerging market thereby weakening those currencies.

Credit Agricole said in a note dated August 21 that it does not see value in the rupee below 70 against the dollar unless foreign capital returns and would not recommend buying it for fundamental reasons at less than 75 against the dollar. This follows a Deutsche Bank note a day earlier which said it sees rupee dropping to around 70 against the dollar soon.

Indian currency has been one of the worst performers having depreciated around 20 per cent in the last three months alone.

The development comes at a time when the country is riling under high current account deficit and the wholesale price inflation is above the central bank’s comfort zone and consumer inflation is still hovering around the double digit mark.

A weaker rupee pushes up the cost of imported fuel, among other commodities. Though the price of domestic fuel is partly de-controlled, as large fuel retailers are majority owned by the government it tends to subsidise petrol, diesel and kerosene to insulate consumers from sharp price volatility.

Either ways, it is going to hit the consumer. If the price is let lose it would have a direct impact while higher subsidies would affect indirectly pushing up prices in the economy as the government borrows more to finance the subsidy, thereby sucking out cash and pushing cost of credit for the industry.

It piles up problems for the central bank, which is to see a change of guard in the next few weeks, as also the ruling political alliance led by the Congress which faces a general election in a few months.

The RBI is juggling with high inflation and depreciating currency amidst a sharp slowdown in the economy. To buoy investments and boost growth, it needs to follow easy money policy but depreciating rupee and an already high inflation ties it hand from loosening the monetary policy.

What it means for investors

Depreciation in currency is bad news for foreign investors, especially those who are short-term investors. The fall in currency means they would pull out fewer dollars than they would otherwise while they repatriate the money on exiting their portfolio investments. This has already made FIIs turn sellers in the Indian market and given their weight, has pulled down the overall market which is now close to one-year lows.

For private equity investors, who bet long term, it should be a great time to invest. But they tend to become cautious given softening valuations in broader market. The trouble lies on the exit front which has anyways been tough for many firms who poured in money in India in the bull period which ended five years ago.

Many of those investments are underwater due to drop in valuations but the currency piles up problems further as the rupee has depreciated over 60 per cent against the dollar since the PE firms put in billions in India in the go-go days of FY07-FY08. Their portfolio firms need to grow faster and their valuations need to match the rise, just to make sure the PE firms get the principal investment in dollar terms out of India when they exit their now mature investments.

(Edited by Joby Puthuparampil Johnson)

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