On Thursday the rupee closed at an all-time low of Rs.50.20 to the dollar. The currency has been under tremendous pressure as the demand for dollars continued unabated. It is not at all surprising that the sharp depreciation has coincided with an accelerated slide in the stock markets. The Sensex recovered partially on Friday but closed well below 9,000. No one is betting against a further decline in the stock prices. India’s predicament with its currency and stock m arkets is by no means unique: currencies of many other emerging markets have also fallen to record lows even as their stock markets plunged. For instance, on Thursday the Indonesian rupiah and the South Korean won fell to their lowest levels since the Asian financial crisis of 1998. The meltdown in the stock markets around the world has been the main contributor to the great turmoil in currency markets. It has prompted a sharp downward shift in the risk appetite of investors. As they continue to exit from the domestic markets, the demand for dollars has increased. Risk-averse investors the world over have been flocking to the safety and liquidity offered by the United States government securities market. This explains the paradox of the dollar remaining strong even as the U.S. economy is seen slipping into a severe recession. The staggering figures of unemployment released recently, along with other bleak economic data, pushed the S&P index on Thursday to its lowest level in over 11 years.
In India, there are other factors besides the outflow of capital that contribute to the decline in the stock prices as well as the rupee depreciation. The extraordinary demand for dollars is also attributed to a freeze in the inter-bank market for dollar funds. On the one hand, this constrained the Indian banks extending trade credits in foreign currency to importers and exporters, and on the other increased the scramble for dollars. The downward pressure on the rupee is expected to continue, if not increase, over the near term. The government’s intervention by way of augmenting dollar inflows through doing away with restrictions on external borrowings and increasing the interest rates on non-resident deposits with banks may be of a limited value at a time of grave financial crisis and the general loss of confidence in the financial system. Over the short term at least, a further depreciation of the rupee can be checked only through strong intervention by the RBI. However, the sharp drawdown in the reserves has already become a cause for worry. The outlook for the rupee and the stock markets will depend on how quickly the global economy, and along with it the domestic economy, overcomes the crisis.