Why the worst of rupee's fall could be over

The worst of rupee's decline may be over as the US Federal Reserve may dial down the pace of monetary tightening in the second half of 2022, a report by SBI Research said. The Indian currency has depreciated almost 7% against the US dollar so far in this year.

Moreover, after analysing the movement of rupee against the US dollar since global financial crisis period, SBI Research found that there were only three instances where the pace of currency depreciation lengthened more than four quarters.

It said that once the currency settled at a lower level, appreciation of currency picked up at a dramatic pace.

Rupee-dollar exchange rate is closely aligned to the dollar index.

Any Appreciation of the dollar leads to depreciation of the rupee/dollar exchange rate. "The correlation between the two is high at 0.86. Regression of rupee exchange rate on dollar index (DXY) from Apr-07 to Jul-22 reveals that 1% change in DXY (or appreciation of dollar) leads to 1.13% change in rupee exchange rate (depreciation of the rupee)," said the SBI study.

The Indian rupee has depreciated by 5.6% vis-à-vis the US dollar since the Russia-Ukraine war broke out. The US dollar Index has appreciated by 9.9% during the same period, thus indicating that much of the weakness in rupee was in lieu of a strong dollar. In fact, the correlation coefficient between rupee/$ exchange rate and DXY has increased to 0.96 since March 21 from 0.63 between January 8 to February 12.

There have been instances in the past which shows that rupee depreciation has been much more than the appreciation of the dollar (like Jan-08 to Feb-12 and Oct-12 to May-14), which had happened because of our weak domestic macro-economic fundamentals.
Since Russia-Ukraine war broke out, RBI’s forex currency assets (forex reserves excluding gold, SDR) have declined by $59 billion. However, FII outflows during the same period amounts to $23 billion only, implying that part of remaining $36 billion (62% of the total decrease in foreign currency assets) decline can be attributed to fall in value of non-dollar reserves amidst steep and secular dollar appreciation, said the SBI study.

"We tried to estimate the amount of decline in FCA held in currency other than dollar by assuming (EUR + Yen + Renminbi) depreciation approximates the non-$ reserves basket: As per our estimate, non-$ currency might comprise 45% of the total foreign currency assets of RBI. RBI might not have used more than $25-30 bn in defending rupee, given the increasing penchant of the regulator to intervene in NDF/Future markets….Rest of the decline might be purely because of valuation…Enough support for rupee is thus still available," said Dr Soumya Kanti Ghosh, group chief economic adviser at State Bank of India.