Indian Rupee (INR) Struggles as Protests over Fuel Prices Threaten Modi Ahead of 2019 Election

Indian Rupee Sinks in Quicksand as Oil Demand Booms

Since the start of this year the India Rupee has faced continuous selling pressure, losing up to 14% of its value against other Asian currencies and around 12% against the Pound.

But it’s the loss against the US Dollar (USD) that is hurting India the most. With the country relying on importing over 80% its oil from world markets – and those barrels of crude having to be paid for in USD – India finds itself caught in the vice-like grip of a falling exchange rate and an oil price that just won’t stop rising.

Demand for oil in India is booming. As the country industrialises and the middle class expands at a breakneck speed, demand for oil has shot through the roof. Consultancy group Wood Mackenzie estimates that by 2024 India will overtake China as the biggest source of oil demand growth in the world.

The subcontinent’s demand for oi is likely to quickly outstrip China’s, they say, with an extra 3.5 million barrels per day needed to meet demand between 2017 and 2035. But there’s just one problem with this forecast: how will India pay for all this oil?

A declining exchange rate has already made the oil import bill for India 14% more expensive in Dollar terms than it was in January, and that’s without factoring in the concurrent rise in the price of oil. Brent crude has already climbed over 20% over the same period, and as President Trump’s oil embargo against Iran begins to bite, the upside potential of further near-term price rises cannot be ruled out.

Drivers and Businesses Feel the Pain, Demand Action

This has led to record high prices for fuel across India, slowing down economic development and causing serious pain for transportation companies and drivers. So keenly have the fuel hikes been felt that the Indian government’s Congress opposition party harnessed public anger and called a recent nationwide strike with protestors demanding the prices of gasoline, diesel and cooking gas be cut. Violence broke out during the strike, with angry mobs burning vehicles and disrupting travel in several states.

This should worry India’s incumbent Prime Minister Narendra Modi, whose Bharatiya Janata Party (BJP) headed government is being blamed for the devaluation in the Rupee. With a national election only seven months away, Modi is desperately looking for ways to limit the economic damage being caused by the plummeting Rupee – something opposition Congress members say he caused.

And while it is true that the government has been embroiled in a  number of scandals, including alleged impropriety during the purchase of some fighter jets, and the deeply unpopular move of banning 86% of all cash (a move which hit the poorest the hardest) – not all blame for the Rupee’s depreciation can be so easily attributed to political incompetence.

Emerging Market Crisis Sweeps up India

India, along with a number of other so-called ‘emerging economies’ (that is, high growth, newly industrialising countries) has been swept up in a global currency crisis that kicked off when the US Federal Reserve began slowly hiking interest rates in 2016/2017. With US rates being set close to zero for the best part of a decade, US Dollars naturally gravitated to countries where interest rates were higher and would attract more yield. Countries, India among them, ended up taking out huge Dollar-denominated loans, with the assumption being that soaring rates of economic growth would allow for this ‘easy money’ be paid back.

But when the Fed started to raise interest rates, it turned out that many of these Dollars wanted to go ‘back home’ to the US, where yields were increasing, in turn causing USD to rise. This meant many emerging markets which were highly leveraged on US Dollar-denominated loans suddenly found themselves struggling to pay the interest.

India, among them, has the misfortune to be among the so-called ‘Fragile Five’. These are the countries deemed the least stable due to currency depreciation, political instability and high current account deficits (the other four being Brazil, Turkey, Indonesia and South Africa). Other countries have it bad, too. Argentina has seen its currency plunge some 90% in the last decade, and recently required a bailout from the IMF.

Can Modi Prevent India from Becoming the Next Argentina?

When it comes to economic stress, India is not in the same league as Argentina, but that may be cold comfort to the citizens suffering from the ongoing escalation in costs. Another worrying factor is that if investors perceive India to be standing on the precipice they are likely to take fright and withdraw their investments from the country, thus turning a problem into a crisis as liquidity is drained form the bond and stock markets. Indeed, if things get worse, Modi may be forced to enact measures to halt the continuing decline of the currency. But what tools does he have at his disposal to do this?

Currently, India primarily earns the Dollars it needs to pay that huge oil import bill via its expansive IT services sector, of which many of the companies operate globally and charge in hard currency. Aside from this, there are remittances from Indians working abroad and repatriating their funds using currency transfer providers. Modi could boost this sector with a sustained injection of investment as a means of boosting its earning potential. This, however, would be more of a long-term move and it would likely take a while to bear fruit, so it would be unlikely to immediately halt the flow of liquidity from India and reverse the exchange rate losses.

Market Intervention, Interest Rates or Demand Reduction?

A more immediate solution would be market intervention – and in fact this is already going on. The Reserve Bank of India (RBI) has some $400bn in reserves which it can use to intervene in currency markets and buy Rupees whenever it looks like a slide is inevitable. This, however, is a dangerous game to play and reserves can be burned through quickly and to little effect. From past experience – in particular the 1997 Asian financial crisis – even with RBI intervention the Rupee slid, meaning firepower can be used up with no results to show.

Another tool that could be used to halt the Rupee’s decline is the interest rate. Rates are currently set at a relatively high 6.5%, although that clearly is not high enough to prevent capital outflows. A quick way to reverse INR’s decline would be to hike the rate by a number of basis points. It doesn’t have to be as extreme as Turkey’s recent example when it boosted interest rates to a whopping 22%, but it could be enough to send a clear signal to the markets that India is serious about halting its currency decline.

This route, however, is not without its drawbacks. Higher interest rates mean higher costs for businesses borrowing to fund development, not to mention substantial pain for mortgage holders and those with high levels of debt. In fact, raising interest rates would likely reverse the Rupee’s weakness but at the cost of risking a recession – which would further undermine India’s ability to pay back its debts. What’s more, raising interest rates during a crisis is usually interpreted by markets as a panic reaction. It is something of a Catch 22 situation.

One other option would be to reduce the domestic demand for oil using a range of fiscal tools combined with conservation measures. After all, buying less oil will have an immediate effect on the oil import bill! Of course, measures such as these would be politically unpopular, and so would likely be a no-no for Mr Modi.

It’s Good to Talk

That only leaves India with one option: talk up its prospects. RBI Governor Urjit Patel is one central banker who doesn’t like to show his face much in public, but perhaps that needs to change. After all, India’s economy is growing at a very healthy clip of around 7% annually – a rate of growth developed economies can only dream of – so why is he hiding in the shadows and not making more of this fact? By coming out and talking up the Indian economy Mr Patel could halt the Rupee’s decline, thus starting a ‘virtuous circle’ leading to lower oil import prices and more affordable debt interest payments.

One thing is clear for now, the emerging market currency crisis is showing no signs of easing, and with the Federal Reserve about to meet for its latest policy meeting investors are anticipating further interest rate rises from Washington. If this is the case, then the Rupee is likely to come under further selling pressure, although with a national election coming into view it remains to be seen what Prime Minister Modi will do to halt its descent – for surely his political future depends on it.

Jason Heppenstall

Jason Heppenstall is a journalist and editor at TorFX.

Contact Jason Heppenstall