The rupee touching a record low of Rs 81 against the US dollar presents fresh concerns for India. While there were multiple reasons for this currency deceleration, primary amongst them is the American currency's strength in the overseas market, which is a negative trend for domestic equities. This, coupled with risk-off moods amid increasing geopolitical risk in Ukraine, has impacted the rupee badly.
According to foreign exchange (forex) traders, intensifying geopolitical risk in Ukraine and rate hikes by the US Fed and Bank of England to control inflation have sapped risk appetite. On Friday, the rupee opened at 81.08 against the greenback and later fell to 81.23, registering a fall of 44 paise over its previous closing.
A day before, the currency rupee plunged by 83 paise—its biggest single-day loss in nearly seven months—to close at an all-time low of 80.79 against the US dollar.
Why Is The Rupee Falling?
The rising interest rates globally are a major reason for the rupee's falling performance. The Bank of England on Thursday opted for another half-percentage point interest rate hike to tackle rising inflation, warning that the economy was already in recession. It increased its interest rate to 2.25 per cent from 1.75 per cent.
On Wednesday, the US Fed announced its third straight rate hike of 0.75 percentage points to a range of 3 to 3.25 per cent. Per forecasts, rates are expected to reach 4.4 per cent by the end of 2022 and 4.6 percent by 2023. A fourth-straight 75 basis-point increase in rate is expected from its November meeting.
Increasing lending rates as a policy action is not restricted to the UK and US alone. The Swiss National Bank on Thursday announced a 0.75-percentage-point hike bringing its policy rate from the negative level for the first time since 2015. This means depositors would not be required to pay to deposit money at the bank.
At the same time, Norway's central bank hiked its lending rate by 0.5 percentage points, the highest level in over a decade.
The only country not to follow the trend has been Japan which managed to retain its loose monetary policy stance. This put the yen at a 24-year low compared to the US dollar.
The US Leads The Way
America's aggressive rate hike would impact local currencies worldwide. Its action would put further pressure on the stock markets.
The key indices of India's stock markets fell on Thursday for the third straight day. Nifty 50 fell 88.55 points or 0.5 per cent to close at 17,629.80 points, while the 30 stock S&P BSE Sensex fell 337.06 points or 0.57 per cent to 59,119.72 points.
Increasing interest rates in the US resulted in US investors withdrawing assets from emerging markets. High interest rates divert capital flows toward the American economy.
The Indian and American interest rates have recently narrowed as the US Fed has been hiking more aggressively than the Reserve Bank of India. A weak rupee would make imports costlier, thus widening the current account deficit.
Increasing trade deficit might result in more prolonged imported inflation, thus forcing the Reserve Bank of India (RBI) to opt for aggressive rate hikes.
Why Is The Plaza Accord Important?
The present currency problems emerging markets face due to US' aggressive rate hikes are reminiscent of the 1980s. From the beginning of 1980 to March 1985, the dollar appreciated by more than 47.9 per cent.
The strong dollar impacted the US manufacturing industry by making imported goods cheaper. Several big companies like IBM and Caterpillar then lobbied Congress to step in, which resulted in the Plaza Accord.
It was an agreement signed in 1985 among Germany, France, the UK, Japan, and the US—the G-5 nations—to depreciate the US dollar to the German Deutsche and Japanese yen in a bid to manipulate exchange rates. The agreement intended to rectify the trade imbalances between the US and Japan and the US and Germany.
However, it ended up correcting US' trade balance with Germany. The agreement is largely held responsible for Japan's lost decade, which was marked by deflation and sluggish economic growth.
The appreciation of the dollar against other currencies has given rise to discussions around having a similar agreement to tackle the appreciation of the dollar. The economic backdrop then was identical to what it is now.
Inflation was soaring, and while several central banks raised rates, many did not. As is the case now, back then, Japan had cut its policy rates from 9 per cent to 5 per cent. Germany's central bank also slashed the lending rate from 9.5 per cent to 5.5 per cent at that time.
Likelihood Of A Similar Agreement Now
China's emergence as a superpower is the most significant geopolitical difference between now and that time. It's one of the biggest trading partners to all major economies—from the US to the UK, Japan, and the European Union.
It was easier to strike an agreement with European countries and Japan then. However, any agreement without China's presence would be futile since the Asian nation now has a large share in those countries' trade.
China has no reason to agree to such an agreement since the yuan is not at a tricky level yet.
Besides China, even the US has very little political will to opt for such an agreement. US Treasury Secretary Janet Yellen has categorically said that market exchange rates should determine dollar's value. A strong dollar is important to deal with US own inflation, which is still considerably higher than the Fed's 2 per cent target.
Should the US enter a recession, then the situation might be different. If the dollar remains strong despite inflation ebbing, it will hurt export business, just like it had in 1985. Despite two-quarters of GDP growth's contraction, the US labour market has remained strong, ruling out the possibility of recession just yet in the US.