Rupee on the watch list

By Alok Mukherjee

NEW DELHI, JUNE 17. With a five per cent depreciation in the exchange rate of the rupee factored into the latest budget, the Union Finance Ministry is cautiously watching the fluctuations in the forex market. Sources in the Ministry suggest that while there is no cause for alarm, what is to be avoided is high volatility in the exchange rate as that impacts adversely on sentiment and distorts the market.

The sources point out that a correction was expected because of the increase in the real effective exchange rate (REER) of the rupee which is a 36-country export based exchange rate with the rates of inflation in those countries included in the index. But the prevailing sentiment in the market had led to some panic action on the part of importers, resulting in a sharp dip in the exchange rate in recent days. However, the intervention of the Reserve Bank of India has stemmed the volatility and the rupee depreciation is now expected to be a gradual affair.

The rupee was expected to be under pressure this year because of some recent developments. On the external front, international capital flows are likely to dwindle this year as well as next year. An analysis by the Associated Chambers of Commerce and Industry has cited projections by the International Monetary Fund (IMF) which feels that the flow of foreign direct investments (FDIs) into emerging markets is likely to slow down in the short to medium term. Net FDI to emerging markets, which had gone up from $35.4 billion in 1992 to $150 billion in 1999, is expected to increase by a mere $3 billion in the current year. Moreover, FDI flows to emerging markets are expected to decline by as much as $8 billion in 2001.

The IMF has also projected that the impact would be particularly severe on crisis-ridden South and East Asian countries such as Indonesia, South Korea, Malaysia, the Philippines and Thailand. In the case of other emerging markets of Asia, including India, the net FDI during the current year is expected to be only $1.7 billion.

Consequently, India's share in global FDI is likely to be meagre this year and the next, putting pressure on the foreign exchange reserves and the exchange rate of the rupee.

The second point of pressure on the rupee is the performance of the domestic economy, especially in terms of exports and imports. While exports have increased by about 30 per cent in April this year, imports have shot up by 43.6 per cent, pushing up the trade deficit to $1.1 billion from $500 million in April last year. The surge in imports this year is mainly accounted for by the increase in non-oil imports which have gone up by 25.7 per cent. Last year, the trade deficit was manageable despite a doubling of the oil import bill because non-oil imports rose only by 1.7 per cent. The situation is different this year.

According to the Assocham analysis, the unprecedented acceleration in industrial production which grew by over 12 per cent in April this year coming on top of increasing growth in the previous five quarters has finally resulted in the need for replenishment of stocks and pushed up the import requirement. The expected continued improvement in exports is also likely to increase the import requirement of the exporting community.

Experts, therefore, feel that the consequence of increased imports would be a sharp rise in the trade deficit this year which would put further pressure on the rupee. The oil import bill is also likely to be substantial as the international oil prices are hovering above $30 a barrel.

With the combined effects of lower inflow of FDI and a rising import bill, industry's expectation of a gradual depreciation of the rupee against the dollar is more or less in line with that of the Government. While the official estimate is that the depreciation by the end of the year would be around five per cent, industry expects it to be around six to seven per cent with the rupee settling down in the 46-47 to a dollar band.

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