Rupee`s decline adds to India`s woes

Updated: Dec 14, 2011, 12:40 PM IST

The rupee is the worst performing currency in Asia. It has fallen more than 18 percent this year against the dollar. India relies on capital inflows to fund its current account deficit, but self-inflicted wounds and investors` worries about troubles elsewhere has been driving capital away. New Delhi, already in turmoil, is running out of firepower to deal with the impact.

Capital flight is the last thing India needs. Its annual financing requirement of USD 119 billion is the highest in Asia, according to a report by Nomura. The trade deficit for the fiscal year ending March 2012 is expected to sharply widen to USD 155 billion-USD 160 billion from USD 104.4 billion a year ago.

Many Indians used to believe that capital would always continue to flow inwards, but in 2010 India was the only BRIC country to experience a decline in foreign direct investment (FDI). In 2011, the combined inflows from FDI and institutional investors declined from USD 16 billion in the first quarter to only USD 4 billion in the second.

The decline of the rupee now threatens to create a negative spiral. India imports more than three-fourth of its oil requirements and oil accounts for two-thirds of the country`s import bill. A rupee depreciation creates inflationary pressure and hits businesses` operating costs. The government also partially subsidizes domestic oil consumption, so any decline in the rupees costs it more too. This is putting pressure on the fiscal deficit which looks like it will breach 5 percent of GDP this year.

Furthermore, the rupee decline creates financial stress for Indian companies which have borrowed in dollars. The list includes Reliance Communications , Suzlon and Tata Motors. In total, Indian companies face a short-term foreign debt maturity of USD 16 billion for the year ending in March 2012, according to Crisil, the Indian rating agency.

The government looked to be trying to turn investor sentiment in a positive direction this month when it announced the opening of the retail sector. The embarrassing subsequent reversal has only made investors even more wary of the India story. The rupee still looks vulnerable.

Context news

-- A weak rupee will inflate the cost of oil imports and could pose an upside risk to the country`s budgeted fiscal deficit target of 4.6 percent of gross domestic product, finance minister Pranab Mukherjee told parliament on December 9.

-- Mukherjee slashed his full-year growth forecast amid slowing domestic and global demand, with officials warning the government was facing a serious balance of trade problem.

-- Asia`s third-largest economy is now expected to grow by 7.25 to 7.5 percent in the fiscal year ending next March, the government said in a mid-year review, down sharply from an estimate of 9 percent issued in February.

-- Mukherjee also said the weakness in the Indian currency would increase the cost of servicing foreign debt and put pressure on the government`s budget.

-- The fall in the rupee was adding to inflationary pressures in the economy, the Reserve Bank of India`s governor Duvvuri Subbarao said on December 9.

-- An unexpectedly steep decline of 5.1 percent in industrial production is expected to put further downward pressure on the rupee which eased on December 12, weighed down by dollar demand from oil refiners.

- The rupee hit a record low of 53.80 against the dollar on Wednesday and has shed more than 18 percent of its value this year to remain the worst performer among major Asian peers.

Bureau Report