Managing rupee's movement

By Oommen A. Ninan

While the Reserve Bank of India is managing the movement of the rupee against the U.S. dollar without much volatility, the long term impact of a depreciation in rupee value poses a fresh threat to the Indian economy.

The rupee fell to a historic session low of 47.21 to a dollar on July 3 as dollar demand from corporates surged after it broke through an important resistant level at 47.10. On July 11, the Indian currency closed at 47.15 a dollar and on July 12 it touched 47.19 in intra-day trading. Though there has not been much dollar demand in the last two days, the rupee has shown further weakness.

The market's perception that the rupee is overvalued in trade- weighted terms and the central bank would manage a well- controlled adjustment in its nominal value has had an impact on sentiment. And, as usual, genuine dollar demand has been augmented by speculative buying by market players. ``However unlike last year when the rupee fell headlong from near 43.50 to 46.90 in six months due to adverse external factors, it is likely to decline at a gentler pace in the present favourable situation,'' said Mr. N. Subramanian, eMecklai, a leading foreign exchange dealing firm.

``The rupee is overvalued by around 4 per cent as per the real effective exchange rate (REER) and we should see a gradual adjustment to correct for this over-valuation. By December-end I see the rupee at around 48.25 against the dollar,'' said Mr. Srinivas Varadarajan, co-head, foreign exchange, Chase Manhattan Bank.

Capital inflows, especially towards portfolio investments, have remained on the positive side this year till June with over $2.45 billion of net investment made in Indian equities and bonds by foreign investors. International oil prices have eased to a comparatively comfortable level of $25 a barrel. India's current account deficit had narrowed by over 50 per cent to $2.3 billion in 2000-01 from over $4.7 billion in the previous year due to a combination of higher exports and lower import growth. ``But for the Finance Ministry's and the central bank's design to avoid excessive strengthening against the dollar the rupee would have appreciated sharply,'' said Mr. Subramanian.

The south west monsoon has begun on a promising note raising hopes of improved agricultural output, especially of foodgrains and a pick-up in rural demand lifting industrial production from the current slump.

Since last October, foreign institutional investors have returned with a bang making aggressive purchases in the domestic stock markets investing over $3 billion during the last eight months. And a debt of $5.5 billion was raised from non-resident Indians under the guise of the India Millennium Deposit scheme through State Bank of India at the peak of the U.S. interest rate cycle, raising the country's foreign debt to over $100 billion. These debts in rupee terms are assuming an alarming size as the domestic currency continuously keeps falling.

With large net inflows, foreign exchange reserves with the central bank have surged to an historic level of over $43 billion. And now there is a fresh outcry from interested quarters to depreciate the rupee to compensate for the fall in value of major currencies against the dollar. The steep depreciation of the rupee since 1990-91 has impacted the economy through cost- push inflation. The rupee devaluation alone has pushed the cost of imported crude oil by over 150 per cent in rupee terms at constant international prices in the last ten years. The consequent inflation has made the manufacturing sector almost unviable either in the domestic or foreign market. The weaker domestic currency has discouraged imports and encouraged inefficient domestic producers, thus denting the purchasing power of the common man and restricting the Government's ability to find funds for economic development and poverty alleviation.

Nevertheless, as the rupee stands poised for another plunge, companies that have managed to survive so far under such harsh conditions, now face a new threat of takeover by foreign interests as domestic assets have become cheaper in dollar terms.

Despite the inflow of over $8 billion towards portfolio investments and by way of foreign deposits, from October 2000 till July 2001, the rupee has not been able to hold against the dollar. One can imagine the impact of a flight of capital on the rupee. However, at current domestic stock prices, there is limited scope for foreign investors to exit. Still, one never knows when the sentiment will change. Indian authorities will then find the task of managing the rupee's fall quite painful.

Send this article to Friends by E-Mail

Section  : Business
Previous : A four-stroke bike from TVS Suzuki
Next     : Monitor