India's external account and currency soaked the pandemic-induced shock well. The rupee now faces another test from the Russia-Ukraine conflict and dial-back of stimulus in the United States (US). The rupee has depreciated over the past few weeks, crossing the 76.5/$ level (as on March 14) from 74.5/$ seen before the Russia-Ukraine conflict that started on February 24. The slide in domestic currency mirrors the developments in other macros: equity markets are volatile and trending down, while yields in the debt market are climbing, and inflation is testing the upper band of the Reserve Bank of India's (RBI) target.

The current uncertainty, wrought by the geopolitical tensions and surging crude oil prices, has weakened the rupee versus the greenback. This is not entirely unexpected though – the long-term trajectory of the rupee-dollar exchange rate since the Global Financial Crisis of 2008 indicates that the currency has a tendency to depreciate during crisis episodes. However, unlike during the taper tantrum of 2013, the rupee has held up quite well this time. This, in part, is attributable to a lower current account deficit (CAD) and a strong build-up of forex reserves. At around $630 billion, India's foreign exchange war chest — the fifth largest in the world — allows the RBI an elbow room to manage an orderly movement of the rupee.

India is not one in crowd on currency stability. Other emerging market currencies too have generally witnessed orderly currency movements, depending on their crude-oil dependence and the extent of repricing of the US Federal Reserve's actions. Some of the fundamental factors, especially the CAD, are worsening due to the spike in crude oil prices. This is already showing up as accelerated depreciation of the rupee against the greenback. Yet, we do not expect the CAD to test the levels of 2013, when India was dubbed as a part of the 'fragile five'.

Further, in the current episode, the relatively high inflation in the US versus India is providing some support to the rupee: in February 2022, the US Consumer Price Index (CPI)-based inflation climbed to 7.9% on-year, versus India's 6.1%. Relatively high inflation in the US lowers time value of the dollar, providing support to the corresponding currency (here, the Indian rupee). India's high oil dependence makes it vulnerable, but the forex shield should provide some buffer. We expect the rupee to see an orderly depreciation and settle at 77.5/$ by March 2023.

Thus, compared with 2013, we are relatively better placed, to weather the external shocks, though not completely insulated. Going ahead, four factors will be key in influencing the rupee's trajectory in fiscal 2023: Brent crude oil prices, the US Fed raising interest rates, extent of foreign portfolio investment flows, and RBI interventions to manage rupee volatility.