Rising Brent crude oil prices are again weighing on the Indian currency. On Thursday, the rupee fell to 96.73 against the dollar, close to its lowest level in two months. In May, it touched an all-time low of 96.96. The RBI, which had provided limited support throughout the week, finally intervened on Friday, selling dollars and pulling the currency back to 96.50. The ongoing rupee depreciation is despite the dollar index trading flat at 101.12. Year-to-date, the rupee is down 7.5 percent and is among the worst-performing Asian currencies. In July so far, it lost nearly 2 percent, reversing the recovery last month, driven by both lower oil prices and the RBI’s measures to raise dollar deposits and foreign debt inflows. Importantly, July’s rupee depreciation has lagged other regional oil-sensitive currencies such as the Indonesian rupiah, the Philippine peso and the Thai baht, indicating that India-specific factors are at play.
Brent crude climbed above $100 a barrel for the first time in two months as escalating tensions in West Asia raised fears of supply disruptions. It means we must pay more dollars for imports, widening the trade deficit and putting downward pressure on the rupee. India isn’t new to trade deficits and traditionally, services exports and remittance inflows offset merchandise trade deficits. Moreover, current account deficits are also offset by capital account comprising FDI and FII dollar inflows. Unfortunately, persistent foreign capital outflows to the tune of $34 billion as of June are creating simultaneous demand for dollars, further exerting pressure on the currency. And as the rupee depreciates, it also raises debt servicing costs. In short, higher oil prices increasing dollar demand, capital outflows reducing dollar supply, and a weakening rupee intensifying balance sheet effects are together causing structural liquidity vulnerability. India does have a $675 billion forex war chest, though useable reserves after netting gold holdings and forward positions are much lower than the headline number.
