India Rupee’s slide toward record low puts India in tight spot

Reuters: Global market tides have swept rupee close to an all-time low, raising current account financing and inflation risks, but for now policymakers are more likely to use small-scale intervention and administrative measures to defend the currency.

The rupee fell 4.8% last month, and was the worst performing Asian currency as the dollar rallied broadly on speculation that the Federal Reserve will begin reducing its monetary stimulus later this year.

Trading at 56.65 per dollar on Tuesday, the rupee is not far from a record low of 57.32 hit on June 22, 2012.

Having a currency at an all-time low is not a great advertisement for the government’s management of the economy ahead of important state elections due in coming months and a national election due within a year.

It will also fuel inflation, make it more difficult to fund a current account deficit that was equivalent to a record 6.7% of gross domestic product in December, and drive up the cost of oil and gold imports that respectively account for 35% and 11% of India’s trade bill.

Further global dollar strength and investor risk aversion could spell danger if it leads to continued rupee weakness, and India’s external deficits worsen.

“Foreign investors may start fleeing Indian markets on escalating balance of payments risks,” said Priyanka Kishore, a currency strategist for Standard Chartered in Mumbai.

Sentiment for the rupee has turned the most bearish since November, according to a recent Reuters poll.

Having attracted around $50 billion in inflows since the start of 2012, the rupee is rendered particularly vulnerable to a withdrawal of foreign funds.

That could make the Reserve Bank of India more cautious when it decides whether to cut interest rates in a policy review due in mid-June.

Finance Ministry officials said on Tuesday, however, that India is likely to raise by $5 billion the $25 billion cap on foreign institutional investment in government debt.

But, with parliament gridlocked by the fallout from a corruption scandal, chances appear slim of Prime Minister Manmohan Singh’s minority coalition government delivering far-reaching reforms to generate heavy capital inflows, as it did last September to stave off the loss of India’s investment grade credit rating.

The RBI is unlikely to intervene heavily in markets to prop up the rupee, as it will want to conserve foreign exchange reserves which at $292 billion are just enough to cover seven months of imports, the lowest import cover since 1996.