For the first time in its history, the INR actually gave a close below the 69/$ mark. While the RBI did try hard to hold the rupee near the 69 level, it was quite clear that the RBI would not persist for too long. The big question now is; what happens to the rupee next? Will it finally breach the Rs.70/$ mark. The answer is that it finally could. Here is why.
Macros are weakening…
If there is one factor that is threatening the value of the rupee, it is the oil price. At $78/bbl and threatening to go higher, that is the single biggest risk factor for the Indian rupee. While the OPEC is likely to increase its output by nearly 1 million bpd, that is going to be too small considering the supply disruptions in the light of the US sanctions imposed on Iran. Iran has been a key member of the OPEC and contributes nearly 4 million barrels of oil per day. Libya, Nigeria and Venezuela are also seeing disruptions in supply and that is also taking a toll on the oil available in the export market. The US reserves have been coming down drastically, and the demand for oil has been showing a steady increase in the last few months. Any supply that comes into this tight market is likely to be immediately lapped up by demand. With refining demand also likely to pick up, the demand for crude will be sharply higher. With India still importing 75% of its daily oil requirements, this will put further pressure on the INR.
Watch the deficits…
One needs to keep an eye on the twin deficits of trade deficit and the current account deficit (CAD). The trade deficit has scaled $15 billion per month and that will continue to put pressure on the INR. The bigger worry will be the CAD levels. At 2%, the CAD is already a major challenge and it is likely to cross the 2.7% mark by the end of this year. That will not only put pressure on the value of the INR but also on the sovereign ratings of India. Trade deficit is widening despite the rising exports because imports are likely to scale $550 billion during the current fiscal year. That will leave the RBI with just 9.5 months of forex cover putting further pressure on the value of the Indian rupee. Deficits could be the key!
Finally, the portfolio flows…
There has been a marginal 10% drop in the FDI flows, but that is still marginal. The bigger worry is that FIIs have taken out nearly $8 billion from debt in the last 3 months. This is despite the broad confidence in the value of the rupee. If the rupee breaches the 70/$ mark, then the fall in the rupee could become much sharper. That is when the vicious cycle of weak rupee and portfolio outflows will start playing on each other. It looks like the RBI may not be too keen to protect the rupee beyond a point considering that reserves are falling. INR may look to breach 70$ mark very soon!
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