The Rupee has fallen from INR63.83/1USD at the beginning of January 2018 to around INR69.96/1USD towards the end of August 2018, marking a fall of over 10% in eight months. In the first week of September, it plummeted further to a new low of INR71.97/1USD taking the YTD fall to close to 13%.

Source: YCharts

Why?

There have been a number of consecutive triggers that have driven the Rupee downwards. On the international front, oil prices have been rising steadily from levels of around USD 50 per barrel a year ago to nearer USD 80 per barrel at present. Unfortunately, India relies on imports to meet around 80% of its oil requirements and any rise in the price of oil drives up the oil import bill and hammers down the Rupee.

Another global affair that has been causing the US Dollar to strengthen has been fears that most leading nations will be pulled into a trade war sparring between the US and China. During times of uncertainty, the value of the US Dollar tends to strengthen.

Lastly, the US has finally abandoned the easy monetary policy that it supported since the financial meltdown in 2008. This, along with improvement in various US economy parameters, has driven up the value of the US bond yields; the yield on 10-year treasuries increased from nearer 2% a year ago to close to 3% at present. With a rise in this benchmark rate, funds have begun to flow back into the US, causing the US Dollar to firm up further.

Economic Impact

Although interest rates in the US and other FII home countries (Europe, Japan, etc.) are still low compared to those in India, investments in India become relatively unattractive, due to the depreciating Rupee. This could cause the rupee to depreciate further.

The depreciating Rupee will drive inflation up, as the import bill, especially for oil, expands. India, which has already been witnessing buoyancy in food prices in recent times, as the government has increased its MSP to farmers, is likely to see the RBI raising benchmark interest rates to keep inflation in check.

Impact on Lending/ Borrowing

With the RBI likely to increase interest rates, on the back of a falling Rupee and upward pressures on inflation, eventually, lenders will have to raise interest rates too. This will impact retail borrowers as well as borrowers across the spectrum of business activities, i.e. large, medium, small and micro enterprises.

·       Enterprises that can raise the price of their products, riding the inflationary wave,may be able to partially or completely pass the increase in interest ratesand input costs to their customers.

·       Enterprises with a large proportion of importedraw materials will find their costs rising and may postpone expansion and, therefore, borrowing. On the flipside, large and small exporters will benefit from the falling value of the rupee and may seek to ramp up their operations to make hay while the rupee depreciates.

·       Retail borrowers, especially those with long term commitments, such as housing loans, may avert higher EMIsby opting for longer tenures, in the hope that the current concoction of factors raising rates will recede.

Tentative Outlook

According to many, the Rupee is still overvalued in real terms,as the factors driving it down continue to have a strong play. This translates into expectations of further depreciation in the Rupee. However, as the RBI has a considerable forex reserves kitty (USD424.5 billion or around Rs29 lakh crore, as at end March 2018) at its disposal, it is well equipped to defend the rupee from steep falls and volatility. With that, any further depreciation is likely to be gradual and well-paced and, therefore, can be built into the business decisions of individuals and enterprises.

The interest rate rise, which is also likely under the current circumstances, is not likely to be sudden and steep either.