The rupee has plunged by around 2% in just a week. Ironically, during the same period, markets saw inflows of up to $2.4 billion. This brings us to the riddle: what is driving the rupee lower to nearly its 8 1/2-month low?

Also, going forward, it appears that the losses will extend. In the absence of any major news from the domestic markets, international forces will likely drive the path of the rupee.

Let's have a look at the five major reasons behind the rupee's weakness:

Dollar on a Horse Ride

The main reason causing the rupee to fall is the immense strength of the Dollar Index, which has touched its three-year high level of 84.30. The record-setting performance of US equities and the improvement in the labor market has made Americans more optimistic about the outlook for the US economy, thereby spurring greater hopes of QE tapering.

The US dollar is looking like gold these days because the Federal Reserve is in a very different position versus the ECB, BoJ, and the RBA. The Federal Reserve is talking about tapering asset purchases at a time when European officials are considering more aggressive monetary easing measures such as negative deposit rates.

The fact that the Eurozone is in a recession is just another reason why investors are snapping up dollars. The monetary policies of the ECB and the BoJ pose a threat to the value of the EUR and JPY, whereas the next move by the Fed should support the dollar. This divergence is bringing the dollar more into the limelight as a 'safe haven'. Capital preservation is just as important as capital appreciation in the present times, and for this reason, the direction of the monetary policy and the consequent implications for the currency has become very important.

Recession in the Euro Zone Is Back On the Table

The rupee is also feeling the pinch of the recession in the Eurozone. The euro, which was seen holding the key level of 1.30, has dropped lower to 1.28 levels on the back of deterioration in the local economic data. For the past month, investors have been selling Euros and buying dollars on the premise that the Eurozone is in a recession, and the ECB is considering more stimulus at a time when the Fed is considering less. If the data shows a deeper contraction in Europe and Mr. Draghi reminds investors that the Central bank is watching the economic data carefully to see if additional action is necessary, the EUR/USD could extend its losses.

Owing to the uncertainty prevailing in Europe and the slump in the international markets, investors prefer to stay away from risky investments. The credit rating agency's downgrade of India to BBB- with a negative outlook, the last of the investment grade, has not helped its cause. Any outward flow of currency or a decrease in investments will put downward pressure on the rupee exchange rate. This global uncertainty has adversely impacted the domestic factors and could lead to a further depreciation of the rupee.

Bleak Fundamental Outlook


The country with high exports will be happier with a depreciating currency; the same does not apply for India. India, on the other hand, does not enjoy this luxury, mainly because of increasing demand for oil, which constitutes a major portion of its import basket. The fall of the oil price to US$90/barrel has helped India to fight the depreciating rupee up to some extent but at the same time the Euro zone, one of India's major trading partners is under a severe economic crisis. This has significantly impacted Indian exports because of reduced demand. Thus India continues to record a current account deficit of around 4.3%, depleting its Forex reserves in the bargain and thus depreciating the rupee.


From time to time, the macro-economic policy has to accord greater emphasis to one segment or the other. At the present time the worry lines are multiple high consumer price inflation, a large fiscal deficit, poor growth, flat industrial production and a balance of payments current account deficit.


No Balance at Balance Of Payments


The Government of India was relaxed with respect to the CAD issue as there was a sharp fall in the commodity prices (of gold and crude oil). A large part of the import bill is driven by other resources as well. The facts show that fertilizer imports surged by 30% in the last two years and coal imports have doubled. Therefore, the problem of CAD continues to persist.


The Indian economy needs to debug its structural reforms and the gap between the imports and exports.


With the reduction in exports and an increase in imports, on one side the current account deficit has increased while on the other, the fiscal deficit is also expected to be above the comfort levels due to increased subsidy. A slowdown in the global economy has adversely reduced the demand for Indian goods. The falling commodity prices on the other hand have increased imports resulting in an imbalance between payments and receipts.


Technically Speaking


We note a recent interesting inverse 'Head & Shoulder' pattern on the USDINR chart where the prices are close to the neckline of 55.40 and were seen facing resistance. In case this pattern holds true and the prices break above 55.40 on a consistent note (say for two weeks), then we might see a wild move in the Indian rupee going forward and we can easily target 57-58 levels. Even psychologically, the levels of 55 are seen as important. The breakout above these levels has triggered stop losses making the investors cover their long positions resulting in further increasing the demand for the dollar.


(The writer is Founder & CEO, India Forex Advisors. The views expressed are his own and do not represent those of Economictimes.com)


This article was originally published in the Economic Times dated 24th May, 2013, written by Abhishek Goenka, Founder & CEO, India Forex Advisors, published by the Economic Times Bureau, New Delhi.