The Covid-19 pandemic has already brought in extraordinary disruption in the world economy and has put the global capital markets in turmoil. With funds in a hurry to exit emerging market assets and return to safer haven like the US treasuries, there has been a very sharp impact on most of the latter currencies including the Indian rupee. Since the beginning of the current month and the intensification of the Covid-19 pandemic globally, the rupee has already depreciated by 5% and had crossed the threshold of Rs. 76 a dollar albeit it has partly climbed back due to the stimulus measures announced by RBI and the Government.

Given the scale and intensity of the Covid crisis, we believe that there are further downside risks to the rupee in the short term but importantly, it is set to remain highly volatile in the near term. While RBI is expected to continue its periodic intervention through open market operations and currency swaps, such intervention is not expected to be duly aggressive with an intent to protect the rupee at a particular level. This is primarily on account of the central bank’s strategy to conserve its foreign currency reserves and also the risk of being tagged as a currency manipulator in a scenario of continuous currency support.

We note that the market panic, like always, is driving demand of instruments issued in the US, EU and Japan which is considered as ‘safe haven’. The said demand is primarily for the respective sovereign issuances and highly rated corporate debt. Such is the demand that US 10 year Government securities are now yielding sub 100 bps, similar trends have been seen in European sovereign debt, where even sub optimal sovereign debt from nations such as Greece has been yielding 982 bps on the back of inferred ECB guarantees. Popular European sovereigns, on the other hand were in fact yielding negative in similar durations. German Bundes bonds and UK Gilt (10 year) are for instance yielding (-) 610 bps and (-) 32 bps, respectively. Similar story is observed in the equity markets of developing nations; India saw historic lows as the Sensex lost 4000 points in a single day, pegging itself at sub 26,000 levels as on March 23 albeit it climbed back of late due to the economic stimulus announced by both RBI and the Government. In the meantime, Dow (US) and DAX (Germany) also showed declines, though offset by periodic recoveries due to movement of funds from the markets of riskier nations. Clearly, as capital leaves the emerging markets like India in search of the aforementioned safe haven asset classes, an unfavorable exchange environment develops.

Nevertheless, in the opinion of Acuité Ratings, the concerns on the depreciation of the rupee are not significant on a relative basis since dollar outflows are rampant across the developing nations. As compared to the 5.3% depreciation of the rupee since March 1, 2020 (till March 25, 2020), the depreciation of a basket of six currencies in developing countries has been visibly higher at 12.9% over the same period. In particular, the Indonesian Rupiah, the Mexican Peso and the Russian Rouble have depreciated by over 15% in the last 3 weeks. The foreign currency reserves have actually increased from USD 442 billion to USD 447 billion over the last one month (Feb 14 – March 13, 2020), reflecting the resilience of the Indian Rupee.

The current account deficit for India which stood at a high of 4.8% of GDP in FY2012 progressively improved over the next 3 years to 0.6% in FY2016 and while it has climbed up to 2.1% in FY2019, it is estimated to remain lower in both FY20 and FY21 given the plunge in international oil prices. We therefore, believe that while the global risk-off environment will continue to make the rupee volatile, the modest current account deficit, the healthy reserves and importantly, the stimulus package being provided by RBI for Covid-19 crisis is likely to lead to fresh FII flows from and offset the downside risks.

We have attempted to assess the exchange rate volatility and envisage a possible expected range in the current calendar year. Accordingly, we have considered one short term scenario and four longer term scenarios, delineating how the exchange rate will evolve under them. The factors considered in these assessments include, Oil Price, Fed Balance Sheet, USD-Yuan Exchange Rate and Net FII Inflows.

The scenario analysis indicates that if the impact of the pandemic is particularly severe with a lockdown in India for the whole of Apr-Jun quarter along with global oil prices averaging at USD 40, the rupee may inch up to the band Rs 81-83 per USD during this period. However, if the average oil prices were to come down to USD 30, the rupee-dollar is likely to stabilize in the band Rs 77-78 by September 2020. In a best case scenario where the virus attack peters out within the next few weeks and the shutdown is quickly lifted, the rupee can actually bounce back to the levels of Rs. 71-73 per USD. Even if the oil prices were to unexpectedly rise on the back of OPEC production cuts in such a rapid revival scenario, the rupee is likely to come down to the band of Rs. 73-74.

A sector-wise analysis by Acuité Ratings on the impact of the rupee depreciation indicates that if the exchange rate were to remain beyond Rs 75 levels, there would be an adverse impact on the chemical, engineering goods, electrical machinery and electronic goods sectors where the scale of imports is significantly high. On the other hand, the sectors that will benefit from the rupee depreciation are clearly the export oriented businesses such as IT services, textiles, leather, pharmaceuticals and some agro commodities.

Annexure: Scenario Analysis: Rupee-Dollar

What changes? : Oil price averages $41/bbl for the rest of the year & Covid -19 pandemic continues only until end April 2020