The Indian economy has posted the fastest growth among all other major economies since the beginning of this year. A sense of confidence in the economy among investors has reflected in the stock market too, with the benchmark Nifty rallying about 9 percent since January.
However, despite a strong growth rate, the rupee has plunged to record lows, shedding more than 12 percent during the year. At present, the rupee is the worst performing Asian currency.
A strong greenback, coupled with a collapse in emerging market currencies and escalation in the global trade war, affected the Indian currency.
The dollar has risen more than 7 percent since the country started imposing tariffs on imports, pressurising other global currencies. The economic crisis in Turkey and Argentina too worsened sentiment.
The impact of the trade standoff between the world’s top two economies and its implications on the Indian economy are still unclear, but it has evidently hit the domestic currency.
The rupee started the year at a two-and-half year high of Rs 63.28 versus the dollar, but thereon it traded with a mild negative bias. However, the trend had turned strongly bearish since March as US and China started imposing tariffs on each other.
Since then, the rupee has weakened more than 11 percent so far. Investors sought safety in the dollar and pulled out of emerging market currencies ahead of a worsening global trade war.
A weak currency impacts an economy in multiple ways:
Higher landing cost for commodities
Currency weakness leads to higher landed cost for commodities imported into the country. Crude oil and gold are instances of such commodities which are traded higher in the domestic market in comparison with their international counterparts.
Impact on current account deficit
A weak currency is likely to widen India's current account deficit further (CAD). A falling rupee versus the dollar increases the cost of imports and increases export revenues in rupee terms.
The current weakness in the rupee is mostly attributed to widening CAD, which is higher due to the crude oil import bill.
As per government data, India's oil import bill rose over 50 percent in the first four months of this fiscal as against the same period last year. Since India imports more than 80 percent of its crude requirement, it is resulting in huge dollar outflows.
Impact on flows
Foreign capital inflows help in bridging the gap between imports and exports. Since our imports are more than exports, there is potential for an increase in the trade deficit.
Adds to inflationary pressure
Currency weakness is likely to result in inflationary pressure as well. Higher costs of commodities would exert pressure on overall economic activity and may force the central bank to tweak its monetary policy to tackle inflation.
Impact on GDP
Higher inflation is likely to hit short term growth prospect of the economy as well. Increased input cost due to weak currency may impact the profit margin of companies.
Rise in interest costs for India Inc
Corporates may also face an additional burden on interest costs when the central bank lifts rates. This may impact sentiment of foreign investors in the stock market.
However, a weak rupee versus the dollar usually benefits exporters and people who are remitting currency into the country.
Source: moneycontrol.com