Permanent Foreign Currency (PFC) flows are spooking the rupee
Over the last few months, the INR has been on a consistent downtrend. From a level of around Rs.64/$, the INR has already gone beyond Rs.68/$ and traders are actually anticipating the level of 70/$ to be breached soon. What exactly has changed in the last few months? Even the RBI is not too keen to intervene considering that exports need a boost anyways.
Food inflation and crude oil
Ask any trader and the first reaction to the weakening rupee will be inflation and crude oil prices. They are actually correct. Higher inflation calls for rate hikes but the RBI is not able to oblige. That pressure has to show up at some point and it is seen in the weak INR. Higher crude prices are putting a huge burden on the trade deficit. The monthly trade deficit is above $13 billion and is expected to cross $15 billion soon. The CAD has also gone beyond 2% and these two deficits are putting pressure.
The issue is more structural
While crude oil and trade deficit appear to be the most obvious answers to the weakening rupee, there is a slightly more structural problem. The reason is that Permanent Foreign Currency (PFC) flows into India have turned negative in the fiscal year 2018. It could go deep into the red in 2019 as depicted in the chart above. What does PFC mean here? It is the summation of the current account deficit + FDI flows + foreign portfolio investments in equity. These 3 combined give us the permanent foreign currency flows. This situation has worsened as the current account deficit has widened to 2% in the last 2 quarters and the FII flows have turned negative. A positive PFC shows that the FDI and FPI can cover the CAD and also partially the fiscal deficit. But a negative PFC means that FDI and FPI flows cannot even cover the CAD. That means you are borrowing for your breakfast which is not good for the INR! ©