USD/INR at ₹97: Is the Rupee Heading Towards ₹100 Per Dollar?

As the rupee hovers near the ₹97 mark against the US dollar, the possibility of dollar 100 rupees is on the minds of many Indian investors. The psychological level of ₹100 per dollar is another important milestone for the Indian currency. However, there are several factors that impact the foreign exchange rate, and we should not consider a specific level of exchange rate as certain or as a forecast.

Some of the important determinants of the USD/INR exchange rate are the demand and supply of the US dollar, India's imports, crude oil price, capital flows, interest rate expectations, global risk appetite, and the US dollar. A falling rupee may benefit Indian companies that are in the export business or earn their income in a foreign currency, but it may hurt companies that are import-intensive.

A more pertinent question for the investors is not whether USD INR 100 is going to happen. Rather, what is the future of inflation, interest rates, corporate earnings, and the Indian market going to be, if the rupee continues its downward trend against the US dollar? Most importantly, what are going to be the impacts of an extended period of weak rupee on gold and foreign investment?

Why Is the Rupee Weakening?

The rupee doesn’t move against the dollar for one single reason. The demand and supply for dollars, and expectations about future economic and financial conditions, all impact the exchange rate.

Suppose the demand for dollars in the Indian market exceeds the supply. Then the rupee can weaken. Here are a couple of possibilities.

1. Increased Demand for Dollars

As previously mentioned, Indian firms and institutions need dollars for imports and for servicing of external debt. When dollar demand increases, it can put downward pressure on the rupee.

2. Crude Oil and Other Imports

India imports a large volume of crude oil. When the international price of crude oil increases, so does the dollar value of India’s crude oil import bill. All other things remaining the same, increasing import demand for dollars can put further downward pressure on the rupee.

3. Foreign Investment Flows

Foreign portfolio flows can influence currency markets. When overseas investors sell Indian assets and repatriate funds, the resulting demand for foreign currency can affect the rupee. Conversely, strong foreign inflows can provide support.

4. US Interest Rates and Global Risk Sentiment

Factors affecting the expectation of US monetary policy can impact global financial flows. When uncertainty is high, investors can prefer dollar-denominated assets which can impact international currency exchange rates.

5. India's External Position

The balance of trade, the current account, foreign exchange reserves, and other external factors can change the supply and demand of the rupee.

Could the Dollar Reach ₹100?

Yes, ₹100 per dollar is technically possible. However, different things can be possible at the same time. Factors beyond the market also affect the movements of a currency. Some of those factors are difficult to predict.

Indian Rupee/ US Dollar (INR/USD) exchange rate is currently at ₹97 per dollar. A rise of approximately 3.1% will take the exchange rate to ₹100 per dollar. Such a movement should not be cause for concern. Relative shifts in inflation and interest rates affect currency exchange rates.

In the short term, the Rupee can appreciate in value, particularly if there are shifts in demand for the Dollar, capital flows, the level of risk in the global markets, and other unrelated market conditions.

In view of the above analysis, INR/USD exchange rate movement should be assessed as part of overall market conditions, rather than focusing exclusively on the movement of the exchange rate. If the INR/USD rate reaches ₹100, it should not be the main consideration when making investment decisions.

What Would ₹100 Per Dollar Mean for India?

Changes in exchange rates impact various segments of the economy in different ways. Some effects are realized gradually, others, suddenly. Answers to the following questions will help evaluate the effect of rupee depreciation to ₹100/- to a dollar.

Imported Goods Could Become More Expensive

When the rupee falls and the price of imports remains unchanged, an importer has to pay more rupees to purchase the dollar needed to buy the import. Consequently, the prices of imported goods and raw materials, production equipment and parts may rise in the domestic market.

When these prices rise, importers may absorb the costs; pass the costs to the consumers; renegotiate prices with the suppliers; or find alternative, cheaper sources of supply. The net impact on prices of the good or service in the market depends on the degree of competitiveness of the good or service, the extent of pass-through, and the importer’s ability to negotiate with the supplier.

Effect on Crude Oil

The Indian economy is affected by rupee depreciation through the price of crude oil. Oil is priced internationally in US dollars. Thus, rupee depreciation increases the rupee price of crude, even if the price of crude remains the same in the international market.

If the price of crude, and the US dollar both appreciate, India is likely to be adversely affected by an increase in the import bill, and the prices of oil and oil-related products.

Inflation Could Face Additional Pressure

Not all inflation is created equal and currency depreciation does not always create immediate large shock levels of inflation, but with rupee depreciation over time, the cost of imported goods and inputs increases. How the domestic economy is structured and if/how firms raise prices to consumers determines the shock levels of inflation. The price of oil and other commodities plays a large role in inflation.

Interest Rates May Matter More

Bouts of imported inflation can get monetary policymakers’ attention. The Reserve Bank of India (RBI) manages price, growth, and financial stability affairs. The currency is also a part of other broad policies.

How Could a Weak Rupee Affect Indian Stocks?

The effect of a weak rupee on Indian stocks is not uniform. Investors need to examine each company's revenue mix, cost structure, foreign-currency exposure and ability to pass higher costs to customers.

Depreciation of the Rupee Benefits Some Exporters

Rupee depreciation has a positive impact on the rupee equivalent of the foreign currency sales of the company.

Exporters in the Information Technology (IT) services sector, which has a large business outside India, are typically cited in the discussion. However, there are several other factors including, but not limited to, pricing, client demand and competition, and employee and vendor costs outside India that also impact the bottom line. Therefore, rupee depreciation may not impact all IT Exporters positively.

Import-Dependent Companies Face Risks

Businesses that import raw materials and components, energy, and finished goods are impacted adversely when the rupee depreciates. The cost for these businesses to procure materials and components as well as energy increase.

Cost increases impact the margins of a business. Strongly pricing powered businesses can push costs to consumers, thereby preserving their margins. However, other businesses may face margin pressure.

Banks and Financial Services Companies are More Complex

For banks and financial institutions, movements in the currency impact different segments differently. Some segments benefit, while others suffer. As a result, the overall impact may not be negative.

Foreign Currency Debt Holding Companies are Vulnerable

Companies that earn in rupees and have liabilities in dollars will be negatively impacted if the rupee depreciates, especially if they do not hedge the exposure.

As such, it is worthwhile for investors to analyze company specific financial statements rather than make broad generalizations based on the rupee’s value.

What Happens to Gold When the Rupee Weakens?

The relationship between the rupee and gold is particularly important for Indian investors. Throughout the world, price quotes for gold are in U.S. dollars. Therefore, a price for gold in rupees implies that a conversion from dollars to rupees has occurred.

Assuming the dollar price of gold is unchanged, as the rupee is converted to dollars at a higher rate (that is, as the rupee weakens), the rupee price of that ounce of gold also increases. Obviously, if the dollar price of gold is also increasing, the rising rupee currency price also represents an increase in the cost of gold in rupees.

In the short-term, a free-falling rupee against the dollar can make imported goods more expensive. However, that does not mean that in the same period the price of gold in the international market will also increase. Interest rates, real yields, the central banks' activities, international investors' risk appetites, and a myriad of other factors affect the price of gold.

How Does a Falling Rupee Affect Foreign Investors?

Ultimately, foreign investors judge the performance of investments in India (and other countries) in terms of their home currency. Therefore, a foreign investor may experience a negative return in home currency (that is, a loss) when an investment in India is denominated in rupees and the rupee is devalued against the home currency of the investor.

Of course, there are many other factors that can determine the investment appeal of a country, including relative growth rates, changes in corporate profits, differences in national interest rates, changes in the policies of governments, and international investors' risk appetites.

Psychological Level of ₹100

Financial market participants often pay attention to round numbers. Crossing the ₹100-per-dollar mark is likely to capture the attention of the news media and markets for the right reasons.

Crossing ₹100 does not mark a change in economic fundamentals of the nation. Transition from ₹99.99 to ₹100, in isolation, does not mark a change in the state of the Indian economy.

It is always important for market participants to analyze the reasons for rupee depreciation vis-à-vis business and policy response. Are the rupee movements short term (noise) or are they sustained? The former shouldn’t be a reason for market participants to alter their investment decisions.

How Investors Should Read a Falling Rupee

A falling rupee is typically a signal of broad macroeconomic trends. It’s not a direct signal for equity investors to take buy or sell actions.

There are several other signals that help investors gage the general trends:

• Crude oil prices: With a weakening rupee and higher oil prices, import costs go up.

• Foreign portfolio flows: Sustained inflows or outflows impact equities and currencies.

• US dollar strength: A strong dollar puts pressure on EM currencies.

• US and Indian interest-rate expectations: Differential changes impact global capital flows.

• Foreign-exchange reserves: Level of reserves indicate external sector exposure and flexible policy actions.

• External sector balance: Trade and CAD data, if analyzed together, give insights on external balance.

• Corporate currency exposure: Hedging and foreign currency debt, if combined with the nature of imports and exports, impact companies differently.

Investors interested to have equity exposure in India must take into consideration the impact of global and domestic macroeconomic policies on various sectors of the economy. They can open an equity trading account to gain equity exposure in India.

Which Indian Sectors Could Be Sensitive to ₹100/USD?

This table describes possible transmission channels, not guaranteed stock-market outcomes. Individual companies within the same sector can respond very differently depending on their financial structure and hedging policies.

Does a Falling Rupee Always Mean a Declining Stock Market?

Not necessarily. There is not a simple one-to-one relationship between the rupee and the equities market.

The rupee plays an important role in inflation. A weak rupee increases the price of imported goods, leading to imported inflation. Additionally, if the rupee is weak, foreign investors may lose money on their investments because of currency conversion. However, if the rupee is weak, that may mean that certain exported goods made a profit, increasing share prices.

Stock prices reflect expectations of the future. For example, if the rupee is weak because of the strength of the US dollar, and India's economy is growing, the stock market may rise. Conversely, if the rupee is falling because of a poor Indian economy, the stock market may fall.

For these reasons, USD/INR should not be the only market-timing indicator.

What Could Prevent USD/INR From Reaching ₹100?

Numerous circumstances could ease the downward pressure on the rupee and improve the INR before it reaches ₹100.

• Should crude oil prices fall, India's dollar demand for energy imports would also decline.

• Investment inflows increase the supply of foreign currencies.

• A less-strong dollar eases the pressure on the EM currencies.

• Rising global risk appetite and positive developments in EM currencies could improve the rupee.

• If the investor sentiment improves in favor of EM, the pressure on the rupee and the Indian currency could ease.

• Expected changes in US and Indian interest rates could impact currency demand and supply.

Several of these developments could occur quickly, making long-term currency forecasts difficult.

What If USD/INR Hits ₹100?

If USD/INR hits ₹100, there will be many reasons behind that move. Some movements will be gradual while others will be more sudden and sharp. Considering India is an emerging market and a less-developed economy, a gradual movement will likely be more beneficial than a sudden sharp drop.

Considering a gradual drop, there will be many factors to watch out for including the cost of crude, imported inflation, changes in interest-rate expectations, and movements in the external position.

A company-level assessment in India will be more beneficial than making a broad assumption that all Indian companies will be affected the same way in the same direction. Some of these considerations will depend on whether a company generates a foreign-currency revenue, has an imported input, has dollar-debt, or has hedging.

Conclusion

Whether the dollar will reach 100 rupees is likely the main topic of discussion as the USD/INR pair trades at around ₹97. A market price at ₹100 is certainly feasible, but predicting when that will happen is impossible. In the meantime, it is important to educate Indian investors about the transmission mechanism.

A falling rupee increases the cost of crude and other imports and puts upward pressure on inflation. A falling rupee negatively impacts foreign currency (dollar) returns and positively impacts ex-US dollar returns.

There are many things that affect the rupee-dollar exchange rate and investors should watch these carefully as well as understand the currency exposure of the companies in which they've invested.