COVID-2019 and the Rupee's Freefall: What to Expect from USD to INR Exchange Rate?
March 18, 2020
4 minutes, 24 seconds Read

COVID-2019 and the Rupee’s Freefall: What to Expect from USD to INR Exchange Rate?

COVID-2019 and the Rupee's Freefall: What to Expect from USD to INR Exchange Rate?

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The novel Coronavirus which originated in the Chinese city of Wuhan in December 2019 has now spread to over 50 countries of the world including parts of Asia, Europe and America. Despite having a death rate of 3 to 4 per cent, the COVID-19 has claimed over 7,000 lives across the globe, majorly in China and Italy, as the virus has affected about 1.8 lakh people. The increasing number of infected people and the fast-growing spread of coronavirus across the globe has caused it to become a global pandemic as declared by the WHO.

Sending the panic waves, the virus has forced complete lockdown and shutdown of many cities causing a global economic slowdown. Consequently, COVID-19 has hit the financial markets badly and at a larger scale in the current month after it became a global pandemic.

While analysts are forecasting for an upcoming economic recession, the central banks of the world adopting an easy monetary policy approach to counter the challenge have taken a rate-cut stand with the Fed reducing policy rates near to zero.

India has not been hit so hard with infected cases just above 130 and fatalities so far limited to just three (as on 17th March) as against thousands of infected cases in the US and Europe apart from Korea and Japan. Nonetheless, the havoc on the rupee has been massive with the rupee depreciating in an unusual manner against the US dollar reaching historic lows.

The rupee which had opened at 72.09 on 2nd March fell to an intraday record low of 74.50 last Friday and closed today, Monday 16th March at 74.27, a depreciation of over INR 2 only in this month so far.

Why the rupee has been hit so hard?

Well, we can trace rupee’s fall majorly to FPI outflows. Till 13th March, FPIs have sold around $7 billon in equity and debt markets and they repatriated the entire amount to their parent countries.

They sold not because the Indian economic fundamentals have suddenly worsened but because they were caught short of cash in their parent countries as equity markets crashed globally.

India was one place where they sold at a good profit as equity markets here had a strong bull run over the last few months and the exchange rate had not moved too adversely. They were therefore in profit, net of their exchange rate, and India was thus their first investment destination. However, post corona caused a financial market crisis, they sold nearly every day of this month and as their demand for USD went up, so did the US dollar-rupee rate.

Having said that, It is also true that India had to bear the dual brunt caused by the spread of coronavirus and the yes bank saga which only added to the quantum of outflow from the Indian market due to uncertainties involved.

The only silver lining in the crisis time has been the crude oil. The spread of the coronavirus led to a slowing down of the global economy, thus forcing the demand for crude down in the global markets. Crude oil prices which have been falling for quite some time nearly crashed after OPEC and Russia parted ways and a “crude war ‘erupted with Saudi Arabia cutting down their selling prices to their customers sharply and hiking production at the same time.

Brent prices dropped from over $50 at the beginning of the month to around $30 as of this evening. The sharp drop in crude prices should generally have been supportive of the rupee and a rupee rally could have been expected due to its positive impact on the current account deficit.

However, the sharp and the unexpectedly large drop in prices were also a boon for the Indian authorities and domestic oil companies as they immediately hedged their medium-term crude requirement by buying in the future oil markets and covering their corresponding US dollar requirements in the domestic spot markets to be completely hedged.

However, as a result of which USD demand rose further and this added to the demand of the FPIs repatriating their funds, led to a large deficit in US dollar supply in the domestic markets causing the rupee to depreciate sharply.

What is RBI’s take on Rupee freefall against Dollar?

RBI has now acted to ease the US dollar deficit in our markets by selling USDs in the spot markets, though not aggressively except on Friday last when they were rumoured to have sold over $1.5 billion and then by opening up a dollar-rupee swap window, starting with $ 2 billion auctions done on  Monday 16th   March.

They have stated that they will follow it up by another $2 billon auction on 23rd March but if the FPI’s continue to sell in the equity markets and repatriate the funds and oil companies continue to hedge their crude requirements as prices dip, RBI would need to be more aggressive. RBI has a large forex reserve and thus enough ammunition to support the rupee against commercial as well as speculative dollar demand, but they as a tradition, are slow to act.

While a further drop in rupee cannot be ruled out, we think RBI is beginning to make it clear that it will act more aggressively in the future if the situation warrants. A major rupee slide from current levels can and should be ruled out.

 

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