India's rupee has been on a slippery slope for some time now against the US dollar. Earlier this week, it declined below 87 to the dollar mark amid rising trade tensions and continued uncertainty around the economic policies of US President Donald Trump. On Thursday, it hit a fresh low of 87.57.
Over the last weekend, Trump announced fresh trade tariffs on Canada, Mexico and China. While tariffs against Canada and Mexico were later postponed, this heightened uncertainty around global trade and tariffs is impacting emerging market currencies, including the rupee, even as dollar index continues to strengthen. Foreign investors have been heavy sellers in emerging markets, including India over the last few months, as they prefer to move capital back into dollar assets.
READ MORE: Rupee plunges 15 paise ;hits record low of 87.58 against US dollar
In January, foreign portfolio investors sold over Rs 78,000 crore worth of Indian stocks and have further pulled out Rs 2,600 crore from the equity market this month till February 5. This drives up demand for the dollar, in turn weakening the rupee.
Suman Chowdhury, chief economist at Acuite Ratings and Research, believes the rupee will continue to be volatile given the strong external headwinds.
"The external environment will continue to be very turbulent. The new US government is creating uncertainties as to how global trade will shape up in the days to come. So, given all this, I think the volatility in the whole forex market will be high, not just with respect to rupee, but with respect to all currencies," he said.
When Trump imposed tariffs on Canada, Mexico and China, they reciprocated with measures of their own. While tariffs on Canada and Mexico were postponed following talks between the leaders, there is still the additional tariff hanging on China, which exports around $400 billion worth to the US. The Chinese yuan has weakened too and the rupee is witnessing collateral effects, pointed out Madan Sabnavis, chief economist at Bank of Baroda.
Trump has also threatened other regions like the European Union with tariffs. In this uncertainty, FIIs are likely to continue selling and the dollar will continue to strengthen. In the past, the Reserve Bank of India sold dollars in the market to protect the rupee, but that only slowed down the decline.
How much more can then the rupee fall? It will all depend on how the central bank reacts going ahead. The Monetary Policy Committee (MPC) of the Reserve Bank is currently meeting and it will announce its interest rate decision on Friday. This will be the first MPC meeting under new Governor Sanjay Malhotra.
With the Union budget staying on its fiscal consolidation course, even as it announced income tax relief for millions to boost demand, many are expecting that the MPC will announce a 25 basis points cut in repo rate this time. But, the continued rupee fall has thrown a curveball.
"At this juncture, selling dollars may only slowdown the process. But left to the market, imported inflation can emanate. Hence, a tricky situation for sure," said Sabnavis. He has also been expecting that a rate cut is on the cards "soon", but the currency issue can lead to some "serious discussion."
In which direction China moves is something to watch out for too. It may well announce more tariffs on goods imported from US or just get more aggressive on exports to other countries, amid the fall in the yuan. China's moves will have a bearing on other EM currencies including the rupee. That will make the current RBI MPC meeting and the decisions it takes all the more important.
Acuite's Chowdhury notes that the RBI is not opting for heavy intervention now in the forex market as it was earlier to ensure the rupee is competitive, but at the same time, it may not allow excessive depreciation.
"I think they are not very intent on protecting a particular level of the rupee. They are kind of allowing that (rupee fall) because they likely believe the rupee will become more competitive and the exports will become more competitive compared to other currencies," he said.
Chowdhury believes much of the depreciation that had to happen to capture the uncertainties in the external environment is done and there may not be a major downside from here, unless there are any new adverse developments.
He expects the rupee will likely to remain around the 87 level till March, and may slip to 88 by December.
A falling rupee can have twin impact. On the one hand, it can drive up imported inflation. For instance, oil gets expensive. But, so far, crude oil prices in the global markets have been stable and there are no indications that the government may want prices at fuel pumps to go up either.
A weak rupee is certainly good for exports from India. But, there are lot of other factors that have a bearing on exports too.
"Exports do get affected if your rupee is maintained at a strong level. So, definitely the negative impact of stronger rupee is there. But weaker rupee does not necessarily mean that exports will happen. It also depends on the global market and the trade regime that we are going to see," added Chowdhury.
Amid all the uncertainty, one will likely see the currency volatility continuing over the next few months.
