External factors put pressure on rupee

By Ommen A. Ninan

MUMBAI, JAN. 2. The rupee will remain under current levels against the U.S. dollar till the announcement of the Union Budget. Further its movement depends on the inflow of foreign currency especially the greenback. The value of the rupee is keenly watched by the central bank and the movements are dictated by fundamentals. However appreciation of the rupee against the dollar from the present levels is unlikely.

``The rupee must have been grossly undervalued in terms of Real Effective Exchange Rate (REER) with the sharp recovery in Euro against the dollar and so should be stable in a range between Rs. 46.50-47 till the presentation of the Union Budget,'' said Mr. N. Subramanian of eMecklai, a leading foreign exchange dealing firm. The new worry for the rupee in the coming year stems from the weakening trend of the Japanese yen against the dollar, which threatens another round of crisis in Southeast Asian currencies. One wonders whether the authorities would again indulge in a self-designed depreciation to preserve competitive advantage. The capital inflows could increase appreciably in the coming year on account of mergers and acquisitions by foreign entities. ``But the rupee is not expected to strengthen a great deal unless the weaker rupee policy changes,'' he added.

The authorities believe that gradually weakening rupee is good for the Indian economy since it boosts India's exports and curtails imports which, also protects the domestic industry from foreign competition and pursue a policy to that effect. The central bank has maintained that the rupee has to depreciate to adjust for the inflation differential between India and the major developed countries. ``On this backdrop, we do not expect the rupee to sharply reverse the long-term trend as irrespective of the foreign fund inflows the central bank would absorb the excess flow and keep the currency stable in terms of REER,'' said Mr. Subramanian.

``Whatever correction we saw in the rupee can be explained by the fact that the rupee was over valued from a REER perspective and the movement (the depreciation of rupee) was a correction for this over valuation,'' said Mr. Srinivas Varadarajan, Co-Head, Foreign Exchange, JP Morgan Securities. Another fact was that the initial part of the financial year 2000-01 exporters had oversold their receivables (dollar).

The correction was acceptable to the authorities as it was warranted by the fundamentals. However from April 2000, a different picture emerged wherein India witnessed capital outflows especially on the portfolio account. The sentiment turned weaker for the rupee because higher oil prices, leads and lags wherein exporters' selling diminished and importers hedging demand increased. This sentiment continued till November.

The rupee fell by 6.85 per cent against the dollar during the year 2000 as it fell from 43.50 to 46.67. Its slide began during May when it slipped past the broad range of 43.40 to 43.80. The rupee always moves or rather falls in fits and starts normally after a prolonged period of stability and this time also it was no exception. ``There was no Pokhran or Kargil playing down the rupee,'' said Mr. Subramanian, ``it was a combination of probably an unfriendly financial budget proposal, steep erosion in value of the Euro and major currencies as well as regional currencies, skyrocketing international prices of crude oil and heavy repatriation of funds by foreign institutional investors (FIIs).''

The central banks' forex reserves which touched an all-time peak of $ 38.34 billion during April, gradually depleted to $34.73 billion in six months prompting State Bank of India, to invite Indian expatriates to subscribe towards dollar deposit scheme to boost the country's reserves. The FIIs bought equities worth $1.67 billion till May turned out big sellers during June and July repatriating almost $545 million exerting tremendous pressure on the rupee. The Indian unit fell by a rupee to 46.60 by June and looked like settling into a range around these levels.

However, the dollar continued with its pervasive strengthening over almost all the international currencies causing the rupee to be overvalued against currencies of India's trading partners thereby curtailing India's export competitiveness and even threatening the domestic industry with cheaper import prices. In these circumstances the authorities tolerated depreciation of the rupee and kept it close to its REER.

The rupee kept falling steadily culminating to an historical low against the dollar at 46.92 on October 30 till the external factors seem to be changing in favour of the rupee. Ironically the rupee fell from close of 46 to its historical low during a time when capital inflows through SBI's IMD issue, which raised $5.5 billion. The almighty dollar is on the retreat against the Euro and other major currencies barring the Yen and the international prices of crude oil declining from a post gulf war high of $ 37 per barrel to below $ 25 per barrel.

The rupee's historical behaviour points to its one-way long-term weakening trend against the dollar. The dollar's appreciation against the rupee in the last three years has been a phenomenal 30 per cent. This has taken place during a period of reasonably strong economic growth rate averaging over 6 per cent annually and capital inflows aggregating a net $27 billion. The depreciation of the rupee has yet to show any appreciable correction in India's balance of payment (BoP) situation. India's trade deficit during the last three fiscal years were $15.51 billion, $ 13.25 billion and $17.10 billion respectively. While exports have gown by 11.02 per cent during the previous three fiscal years the imports have outpaced with a growth of over 13 per cent during this period.

``We believe that the only hope for India to correct the trade imbalance and emerge as an economic power in this century rests chiefly on the technology sector,'' Mr. Subramanian felt. It is all the more important when looked at India's external debt, which must have surpassed over $ 100 billion. Further the Government is unable to pursue hard decisions to correct weaknesses in public finances and modernise the country's pervasive and largely under performing public sector. Also, most of the State governments have not begun the process of restructuring their loss-making electricity boards. The high borrowing (about 66 per cent of GDP) requirement of all levels of Government and their enterprises would eat into 40 per cent of domestic savings, constraining growth and development.

The outlook of Indian currency in 2001 would depend on the likely capital flows especially from the foreign direct investments (FDIs), external commercial borrowings (ECBs), foreign portfolio inflows and the nature of inflows from the invisible accounts. ``Exports from software sector are keenly watched as there is a slump in the high technology sector especially in the developed world,'' said Mr. Varadarajan. Any movement in the value of the rupee will be keenly monitored by the Reserve Bank of India to prevent an undue volatility and will be there to even out demand and supply mismatches.

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