Rupee sags amid jitters about looming conflicts

NEW DELHI — The Indian rupee fell to the U.S. dollar for six consecutive days earlier this month, the result of investors’ moves to dump emerging currencies. The sell-off was prompted by concerns about escalating tensions between the U.S. and North Korea.

But market watchers say the rupee-selling may also reflect jitters over a potential military conflict between India and China.

The Reserve Bank of India’s reference rupee rate has the currency at around 64 to the dollar, slightly stronger than the average year-to-date¬†rate. But it weakened for six consecutive trading days to Aug. 11. The last time the currency fell for six straight¬†days was in November, when Indian Prime Minister Narendra Modi made a surprise announcement that the country’s two largest banknotes would be abolished as a measure to counter corruption.

The rupee fell 0.85% over the six days, which is not exactly a major drop compared to the 2.76% plunge in November. But over the past two weeks, it has grown softer than the Indonesian rupiah, which has been given a “fragile five” designation by Morgan Stanley for the vulnerability of its currency due to the country’s heavy reliance on foreign funds for its economic growth.

In its report released Aug. 11, Indian credit-rating agency ICRA said, “Political developments in the U.S. and geopolitical tensions would continue to inordinately influence exchange rate movements in the near term.” Although the report did not specifically mention the causes of the geopolitical tension, one of the report’s authors said it includes friction between China and India, in addition to geopolitical risk due to the tensions between the U.S. and North Korea.

While the report estimates the Indian rupee’s trading range until next March at 62-65 rupees to the dollar, which is tipped toward a stronger rupee, the extent of the rupee’s potential fall due to a potential China-India war is unpredictable, the author said.

Border squabble

Chinese and Indian forces have squared off in border areas that also involve Bhutan, an Indian ally, since June 16. The standoff was triggered when China attempted to build a road through an area in the Doklam Plateau claimed by both China and Bhutan. The latter requested India for help, and the Indian army blocked the Chinese move, raising tensions.

While there has since been no military actions like exchanges of gunfire, hundreds of troops from both China and India are standing by on either side of the border, and each country has over 10,000 troops supporting them.

An official of India’s ruling Bharatiya Janata Party indicated wariness about a potential escalation in tensions with China, and said it is a good idea to sell Indian rupees for dollars before such a scenario comes true, as the rupee could fall 7-8%.

The rupee is now at its highest level in two years as foreign investors have continued to buy Indian stocks and bonds on the relative strength of the country’s economy. The Indian government has maintained an austerity policy with a target to limit the fiscal deficit to 3% of gross domestic product in fiscal 2018. Economically, there is little reason the rupee should weaken.

For now, the prevailing view is that both Modi and Chinese President Xi Jinping want to avoid military conflict. Xi has blasted India in the pages of the Communist Party-affiliated Global Times, but the apparent move to fuel tensions is viewed by many as an attempt to put on a combative front. He fears a weak-kneed reaction may only provide fodder for his political opponents in a sensitive period ahead of the expected start of his second term as president.

Even if an armed conflict does happen, an Indian government official said, the international community is expected to intervene within 10 days.

If a serious conflict is unlikely, then overly pessimistic scenarios, such as India being forced to issue large amounts of bonds to fund a war and significantly impairing its fiscal position, or a serious deterioration in consumer confidence, are not realistic, at least for now.

The military escalation is unlikely to trigger a nosedive of the rupee, if history is any guide. When India and Pakistan sent troops to the border and the risk of nuclear war escalated in 2001 to 2002, the Indian rupee dropped only around 3%.

Still, India’s economy and financial market have since become much more internationalized, and the volume of foreign investors’ stock and bond trading has increased significantly, potentially magnifying the impact. Furthermore, if an escalation of the India-China border conflict coincides with a military emergency between the U.S. and North Korea, the international community may fail to take effective action to broker peace between India and China.

It seems that a hedge against a precipitous plunge in the Indian rupee has become a realistic course of action for foreign businesses operating in India with exposure to currency risk.

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