The Indian rupee continues to fall on hard times. The currency has been hit harder than other major emerging-market currencies across the region. An obsession with gold and foreign outflows are all the two biggest contributors to the rupee’s slide.
"In the FX markets - there’s volatility, and then there’s the Indian rupee." Jon Gordon said.
The currency is Asia ex-Japan’s worst performer in this year, falling more than 8 percent. It’s practically been on a one-way street since mid 2011, culminating with last-week’s all-time low of 60.76 rupees to the U.S. dollar. And as you can see, that’s tracked the country’s rising current account deficit.
The U.S. Federal Reserve’s signal that it plans to curb stimulus has hurt risk assets across the region, but why has India in particular been so hard hit?
Well, the Reserve Bank of India seems to think it’s due in part to the country’s gold obsession. The more rupees exchanged for gold, the more the currency falls. Policy makers have introduced curbs on the precious metal in the hopes that will help narrow that current account deficit.
Another part of the problem is foreign outflows. Foreign institutional investors have pulled more than 7 billion dollars out of Indian assets in June alone, pressuring the market, though that may be near an end.
"The concern more short-term, really, is that as hot money pulls back from markets with yields backing up in the U.S., India is somewhat exposed to that, but that’s probably played its course now and we would look for an improving equity market on evidence that that current account deficit is starting to narrow." Mark Konyn, CEO of Cathay Conning Asset Management said.
Foreign investment also remains limited, despite government promises to further liberalize ownership rules in the country.
Rupee weakness doesn’t necessarily have to equal crisis though.
While bigger FX reserves would give the government more firepower to intervene, a weak currency could actually benefit the service providers that form a big chunk of India’s economy. Think the IT guys.
But the risk is for the rupee to get stuck in a downward cycle, with rising import costs and the current account deficit scaring away more foreign investment dollars, and so weakening the currency further.
That would make the high-single digit growth of two years ago that much harder to recapture.
And could tempt the central bank into more desperate policy that could endanger the other parts of the economy still on solid footing.