The rupee slumped on to a record closing low of 75.20 against the U.S. dollar on 20th March 2020.

More on News:

  • The rupee has now depreciated by more than 5.3% in 2020, with the bulk of its losses, a 4.1% slide, having occurred in March.
  • The deepening concerns about economic slowdown is inducing investors to dump assets, especially in emerging economies and buy safe assets like the U.S dollar.

Source: The Hindu

  • As on March 20, foreign institutional investors (FIIs) had sold more than $12 billion, of shares and bonds. 
  • This outflow has coincided with the sharp fall in the equity market’s key gauge, the 30-stock S&P BSE Sensex, which has slumped 22% so far in March.
  • Overseas investors have dumped Indian equities and debt on a scale not seen since the taper tantrum of 2013, when news that the U.S. was going to gradually wind down its GFC-triggered quantitative easing spurred an exodus out of emerging market assets.

Quantitative Easing:

  • It is a form of unconventional monetary policy in which a central bank purchases longer-term government securities or other types of securities from the open market in order to increase the money supply and encourage lending and investment. 
  • Buying these securities adds new money to the economy, and also serves to lower interest rates by bidding up fixed-income securities.
  • When short-term interest rates are at or approaching zero, normal open market operations, which target interest rates, are no longer effective, so instead a central bank can target specified amounts of assets to purchase.

Taper Tantrum:

  • It describes the 2013 surge in the U.S. Treasury yields, resulting from the Federal Reserve's (Fed) announcement of future tapering of its policy of quantitative easing.
  • The Fed announced that it would be reducing the pace of its purchases of Treasury bonds, to reduce the amount of money it was feeding into the economy. 
  • The ensuing rise in bond yields in reaction to the announcement was referred to as a taper tantrum in financial media. 
  • In the period since the 2008 financial crisis the Fed had tripled the size of its balance sheet from around $1 trillion to around $3 trillion by purchasing almost $2 trillion in Treasury bonds and other financial assets to prop up the market. 
  • Investors had come to depend on ongoing massive Fed support for asset prices through its ongoing purchases. 
  • This prospective policy of reducing the rate of Fed asset purchases represented a massive negative shock to investor expectations, as the Fed had become one of the world's biggest buyers. 
  • As with any reduction in demand, with reduced Fed purchases (bond) prices would fall. 
  • Bond investors responded immediately to the prospect of future decline in bond prices by selling bonds, depressing the price of bonds as a result. 
  • Of course, falling bond prices always mean higher yields, so yields on U.S. Treasuries shot up.

Rationale behind the Rupee Plunge:

  • COVID 19 Pandemic has created an economic uncertainty for the future, thereby inducing investors to conserve the most crucial asset during times of crisis i.e cash and more specifically the U.S dollar.
    • In 2008 too a similar situation was witnessed during the times of Global Financial crisis when the dollar strengthened about 22% against the Euro.
  • The rupee’s decline has been part of a broad trend as most currencies across the globe have weakened against their U.S. counterpart. 
    • The dollar index, which gauges the greenback’s strength against a basket of six currencies, has gained almost 4% so far this month.
  • The Pandemic has not even spared safe havens including Gold. The yellow metal too has been sold by investors looking to hold the most liquid and most fungible of all assets — the U.S. dollar.

Road Ahead:

  • Its hard to see rupee improving in the short term as the world is heading towards recession and India’s own domestic economy is struggling to reverse an extended slowdown (owing to decreased consumption and investment in the economy).
  • However there are some comforting factors like -
    • India’s foreign exchange reserves as on March 13 amounted to a total of almost $482 billion
      • With this RBI can intervene to ensure that a sudden shortage of dollar supply does not exacerbate the weakening trend in the rupee.
    • Also Oil Prices, which is one the largest contributors to India’s import bill, has dramatically declined this month with Brent crude oil futures having slumped more than 46% to $26.98 as on March 20.
      • With neither Saudi Arabia nor Russia appearing to end their price war, oil may bring some respite to the rupee.
    • Dollar might become riskier to hold if more states like California impose severe movement curbs to control the pandemic ,which may create unemployment pressure and recessionary trends in the U.S. 

Still, to complicate matters on the outlook, the RBI is most likely to cut interest rates in the very near future to support the sagging economy at this juncture, a move that could potentially again add to the downward pressure on the rupee.

Also read: Structural Reasons For Economic Slowdown

Economic Slowdown - Bottom Or Mirage?


Image Source: The Hindu