What a weakening rupee means for India – and your portfolio

In March the rupee was at 82.77 to the US dollar. Currently, it is around 85.25, which is a drop of about 3%. We will look at the reasons for this depreciation, but the important point is that our external situation – as measured by our current account deficit (CAD) and balance of payments (BoP) – is under control.

In October and November, foreign portfolio investors (FPIs) were significant net sellers of Indian equities, which put pressure on the rupee and kicked off the latest phase of depreciation. This event must be seen in the context of global developments. 

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To state the obvious, the rupee is measured against the US dollar, so the strength of the dollar impacts our currency. The strength or weakness of the US dollar is measured against a basket of six major currencies with defined weights. This basket is referred to as DXY. The major impetus for DXY movement is interest rate changes, or expectations such changes, by the US Federal Reserve.

Trump effect

Ever since the US presidential election in November, there have been certain expectations on the policies Donald Trump will implement. These are expected to lead to higher inflation and a higher fiscal deficit for the US. In light of this, the market has toned down its expectations of rate cuts by the Fed over the next year, from one percentage point to half a percentage point. On top of this, investments from all over the world are flowing into the US.

This has led to the strengthening of DXY to 108 from about 100 in September. DXY’s strength is putting pressure on currencies worldwide, particularly in Asia-Pacific. This is relevant for us, as Asia-Pacific economies are competitors for exports. 

The RBI has been supportive of the rupee, which can be gauged from the depletion of our forex reserves to $653 billion from a peak of $705 billion. Apart from the selloff by FPIs or other outflows, this represents RBI’s move to release US dollars to support the rupee. Note that the RBI does not look at any particular exchange rate, and does this simply to curb excessive volatility.

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As we mentioned earlier, our external sector is under control. The CAD – at about 0.7% of GDP in 2023-24 and projected to be about 1% of GDP in 2024-25 – is very much par for the course. We have seen worse times. 

On BoP we are mostly positive. FDI flows, though decelerating a bit at the margin, are positive. FPIs sold heavily in October and November, but have been net buyers in December. 

NRI remittances are the highest in the world, higher than those of non-resident Chinese and Mexicans. To summarise this part, weakness in the rupee is due to technical reasons such as DXY strength and the weakening of Asian peer group currencies, but there is no major cause for concern.

How it affects your portfolio

Coming to the impact on your portfolio, from a fundamental perspective, it’s adverse. It has consequences for imports as the landed cost of crude oil and other items is that much higher. This is referred to as ‘imported inflation’. 

However, to put things in perspective, the rupee has always been depreciating. In January 1973 it was at 8 to the dollar. Over these 52 years, it has depreciated at an annualised rate of 4.65%. In the current phase, from March to December, the rupee has depreciated 3%. If we annualise this, it works out to 3.7%, which is lower than the historical rate. Over the past five decades, equity and fixed-income markets have delivered decent returns despite the rupee’s depreciation.

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Certain investments will benefit from the rupee’s depreciation. Your investments abroad, either through mutual funds that take investments in rupees and put the money abroad or through the Liberalised Remittance Scheme (LRS) quota of $250,000 a financial year, benefit from this. Returns from gold are not just returns from gold, but have currency depreciation factored into them. 

However, it’s important to ensure that your investment portfolio is based on your objectives and risk appetite, not on tax efficiency or currency depreciation, which are a bonus.

Joydeep Sen is a corporate trainer (financial markets) and author.