What is causing the decline?
The rupee was already weakening before the present crisis because of continuous portfolio outflows from equities and, to some extent, from bonds.
“The global tariff crisis, especially the 50 per cent tariff imposed by the US on India, added to the pressure,” says Abheek Barua, an independent economist.
Over the past month, the conflict in West Asia and the rise in global oil prices have hurt sentiment. India’s heavy dependence on fuel and fertiliser imports makes it especially vulnerable.
Uncertainty over how long the war will continue has created acute risk aversion. “In such periods, investors move towards the safety of the US dollar, causing it to strengthen against other currencies,” says Barua.
Will it weaken further?
How much further the rupee falls will depend on how long the conflict lasts. India’s dependence on West Asia for oil, oil derivatives, fertilisers, and fertiliser inputs will intensify the pressure. While India has turned to Russia for oil, that supply comes at a heavy premium. Its oil bill has already risen sharply.
A prolonged conflict could worsen India’s external balance. “Higher oil prices and a weak rupee will widen the trade deficit if the war persists. A wider trade deficit will put further pressure on the rupee,” says Joseph Thomas, head of research, Emkay Wealth Management.
In the worst-case scenario, Barua says the rupee could move towards 100/USD. But if the conflict is resolved in the next few weeks, it could retrace its path and move closer to 91-92.
Impact on household finances
A weakening rupee affects households across the board.
Consumers have received protection on basic fuels such as diesel, petrol, and liquefied petroleum gas (LPG) because of the cut in special additional excise duty. But there is no certainty regarding how long the government can sustain that protection. Further cuts in excise duty may not be possible if oil prices rise further, as that would create a fiscal problem.
Aviation turbine fuel has already become expensive. This will raise air travel costs. “Rising fertiliser prices could feed into food inflation,” says Barua.
If fuel prices are allowed to rise in future, the cost of most manufactured items will increase, resulting in cost-push inflation.
Amid tighter liquidity and higher bond yields, accessing loans may also become harder. “Banks will become more selective and prefer high-quality borrowers,” says Barua.
Any increase in the repo rate in future will translate into higher interest rates on floating-rate loans.
Families paying for overseas education are directly exposed to rupee depreciation.
A weaker rupee will also raise import costs and inflation in the economy.
There is, however, some room for optimism. Thomas says that since the current situation is linked to the ongoing war, the price impact may be transitory rather than long-lasting.
Households should also remember that the rupee tends to weaken structurally against the dollar. “Even over the long term, it depreciates about 4-5 per cent annually,” says Subho Moulik, founder & chief executive officer (CEO), Appreciate.
How should households respond?
Households must recognise that shocks from the global system are becoming more frequent for India. With inflation likely to rise, safe and liquid holdings should form a part of every portfolio. “Households should keep a meaningful share of money in safe instruments, such as fixed deposits and liquid mutual funds, even if they yield less. Liquidity matters because households may face sudden events that require immediate cash,” says Barua.
How to plan for foreign currency goals?
Families should think carefully about whether they can truly afford overseas education in a volatile currency environment. “They should keep an extra buffer for overseas education and decide its size with care. Even if the currency later reverses, families must be prepared for periods of sharply higher costs during the course,” says Barua.
A child’s university education will be priced in dollars. “The practical step is to match asset denomination to goal denomination. Keeping the entire portfolio in rupees while goals are priced in dollars guarantees quiet, compounding erosion,” says Moulik.
Here are a few investments that can help investors counter the impact of a depreciating rupee.
Global funds from Indian fund houses
Investors may begin with about a 20 per cent allocation to US equity funds withing a long-term equity portfolio. A stronger dollar increases the rupee value of such dollar-denominated holdings.
“International mutual funds offered by Indian fund houses offer convenience because the investor stays within the Indian regulatory and tax framework,” says Pratik Bagaria, principal officer, Dezerv.
They provide access to businesses that do not exist in India. “Restricting oneself to India means ignoring most of the global opportunity set,” says Bagaria.
They also provide genuine portfolio diversification because Indian and US equities do not move in the same direction all the time.
The biggest constraint to investing via this route today is the $7 billion industry-wide overseas investment cap. “The cap has forced many quality international schemes to close for fresh investment,” says Bagaria.
“Subscriptions can halt and units can trade at steep premiums when the cap is hit,” says Moulik. He adds that investors should avoid buying India-domiciled international mutual funds when they trade at a premium to their net asset value (NAV).
The tax treatment of international funds is less favourable than that of domestic equity.
For most Indian investors taking their first step into international investing, the US should be the natural starting point. A global or diversified international fund makes sense if the investor already has some US exposure.
Investors should take the passive route when investing in the US or globally. “Active managers consistently struggle to generate alpha in the US market over long periods,” says Bagaria.
Gold as a hedge
Gold has traditionally been one of the most effective hedges against rupee depreciation. When the rupee depreciates against the dollar, the rupee price of gold rises even if its dollar price does not move much. “If global uncertainty pushes up gold prices while the rupee is depreciating, Indian investors get a double benefit,” says Arvind Rao, founder, Arvind Rao & Associates.
Use LRS route
Investors may also use the liberalised remittance scheme (LRS) route to invest in foreign exchange-traded funds (ETFs), mutual funds, and stocks.
The LRS route has no industry-wide ceiling. A family of four can invest up to $1 million overseas annually.
The route has a few downsides. The 20 per cent tax collected at source (TCS) on remittances above Rs 10 lakh creates a liquidity drag, though investors can recover it.
Schedule FA disclosure is mandatory in income-tax return (ITR) every year for resident Indians holding foreign assets. The Black Money Act penalty for non-disclosure is Rs 10 lakh per year.
Indian resident investors also face US estate tax exposure above $60,000 in US assets.
Investors should invest systematically, not reactively. “The worst form of LRS investing is a one-time remittance triggered by rupee-crisis headlines,” says Moulik.
Investors should opt for ETFs initially before investing in individual stocks. They should hold foreign stocks and ETFs for 24 months or more to enjoy long-term capital gains treatment.
Investors receiving meaningful dividend income from US stocks must file Form 67 before submitting their ITR to claim the tax credit.
