Stock Money exchange rupees
UAE dirhams and Indian rupees at Lulu Exchange in Sharjah Image Credit: Ahmed Ramzan/Gulf News

Dubai: If Indian expats were hoping to send more money back home, it would be ideal to do it this week as exchange rates are seen staying remittance-friendly against the US dollar and the UAE dirham in the coming days.

The value of the Indian rupee versus the UAE dirham was at 21.51 on Monday, and at 79 against the US dollar - with analysts foreseeing a bigger drop. Check the latest forex rates here.

Weakness in the rupee's value against the US dollar will be automatically reflected in its exchange rate with the UAE dirham as the UAE currency is pegged to the dollar.

The depreciation in the currency's value is primarily attributed to India's ballooning trade gap and rising capital outflows, which create new risks for the rupee, just as the currency's plunge to a record low adds to inflation woes.

Deteriorating Balances

"India's external balances are deteriorating," economists at Goldman Sachs Group Inc. wrote in a note Thursday, citing the terms-of-trade shock from higher commodities prices and weakening global growth.

"Going forward, the trajectory of the rupee is likely to be pushed weaker versus the dollar on account of the deteriorating external balances."

While the Reserve Bank of India has begun raising rates, which usually supports currencies, the moves also deflate the domestic stock market, and can accelerate rupee-weakening outflows. Meanwhile, demand for dollars is rising, further pressuring the currency and forcing the RBI to dip into its reserves pile to support it.

The central bank says the risks are so far manageable and the external sector is "well-buffered to withstand the ongoing terms-of-trade shocks and portfolio outflows."

How trade balance or a deficit affects a currency's exchange rate
The balance of trade (i.e. the difference in value between a country's imports and exports, which reflects higher or lower demand for a currency) can affect currency exchange rates.

A country with a high demand for its goods tends to export more than it imports, increasing demand for its currency. A country that imports more than it exports will have less demand for its currency.
Stock Money exchange rupees
The value of the Indian rupee versus the UAE dirham was at 21.51 on Monday, and at 79 against the US dollar.

The following four indicators require a deeper look at the challenges from India's external finances:

Widening Deficit

A shortfall in India's current account - the broadest measure of trade - will probably widen to 2.9 per cent of gross domestic product in the fiscal year ending March 31, according to a Bloomberg survey in late June, nearly double the level seen in the previous year. A widening account deficit naturally implies the need for external financing.

"The current account deficit widening has been relentless," said Rahul Bajoira, an economist with Barclays Plc in India. "The broad-based increase in commodity prices is likely to keep the deficit sticky in the near term and, along with capital outflows, exacerbate the external financing requirements."

If it starts to approach 4 per cent of GDP, policy makers would need to take both fiscal and monetary steps, he said.

Falling Reserves

India's foreign exchange reserves, which can cover about 10 months of imports, have slumped more than $50 billion from a peak in September to $587 billion in the week to June 17 as the RBI seeks to stabilise the currency and importers seek more dollars for costly energy imports.

The RBI is fighting on several fronts to slow the rupee's decline, while its stated stance is that it intervenes to curb currency volatility and not influence its direction. Nevertheless, the RBI has spent $18 billion in the spot market to support the rupee between January and April, latest data from the central bank showed.

How foreign reserves affect exchange rates?
It can be understood that foreign reserves act as a shock absorber against factors that can negatively affect a currency's exchange rate.

So a nation's central bank uses its currency reserves to help maintain a steady rate, buying or selling depending on which direction they want exchange prices to go.
Stock - Indian Rupee
Will the Indian rupee stay weak this week? Indicators point to a decline.

Costlier Imports

India's trade deficit widened to an all-time high of $24 billion in May after the nation's import bill almost doubled because of a surge in global crude oil prices. Meanwhile, exports slowed as the Russia-Ukraine conflict and tighter monetary policies globally weigh on growth.

"A broader increase in commodity bill will underpin annual imports - a mix of crude oil, coal, fertilisers, edible oils purchases," said Radhika Rao, senior economist with Singapore-based DBS Bank Ltd. She estimates a 20 per cent increase in overall imports, out-pacing export growth. "This will likely leave the merchandise trade deficit about 40 per cent wider this year."

Capital Flows

Foreign investors have pulled out more than $32 billion from Indian equities in the last one year, making it the worst performer in Asia after Taiwan. There has been an outflow from bonds too, placing India just behind Indonesia and Malaysia.

"With portfolio outflows expected to continue amid weakening global equity performance, and further deterioration in balance of payments in coming months, the risks of rupee under-performance cannot be discounted," said Madhavi Arora, lead economist at India-based Emkay Global Financial Services Ltd.