The Hindu : Rupee's strength: Not an unalloyed blessing

Online edition of India's National Newspaper
Wednesday, May 21, 2003

Business

Business

Rupee's strength: Not an unalloyed blessing

By C. R. L. Narasimhan

The Indian rupee that has been on a rising trend against the dollar went below the 47 mark on May 19 and has continued its strength the next day. The significance of this is largely psychological: the appreciating rupee has reached a level (against the dollar) last seen some 23 months ago, on June 28, 2001.

The rupee's gain against the dollar is now no longer seen as an aberration, something that will automatically correct itself and follow (what seemed to be) the long-established pattern of forever depreciating against the dollar. In mid-May 2002 when the dollar rupee rate was 49.08, there were several experts who were confidently predicting a Rs. 50 level to the dollar.

Since then the rupee has gained 208 paise, a large gain even when measured over such a long time span. Incidentally, for those whose profession it is to take positions in foreign currencies, the most notable among them being the forex dealers, there are opportunities for making money in much smaller currency movements and over much shorter-time spans.

Among bankers and others who regularly trade in currencies a Rs. 2 appreciation in terms of the dollar is a seismic shift, unthinkable during a relatively short trading period.

The true significance of the rupee appreciation is to be seen elsewhere, notably in its perception altering nature. Not so long ago the Reserve Bank of India and the Government were urging the exporters to surrender their export proceeds (that is convert their dollar earnings into rupees) within the timeframe allowed and initiating penal action against those who did not follow. Now that the perception of scarce forex has been so convincingly altered, there is no reason for exporters or anyone else to hold back their dollar remittances into the country. An appreciating rupee and more importantly the expectation of a further appreciation have effectively turned currency orthodoxy on its head. It is no longer mandatory to book a forward cover for imports.

The same invoice value can be met with fewer rupees. And exporters are selling dollars forward. The dollar-rupee premium has come down over most periods and according to market sources might even vanish over certain periods. The net result has been an increase in the supply of dollars and given the insufficient demand for it has only meant a rupee appreciation.

There is however a grave danger in assuming that the dollar will move down against the rupee for an indefinite period. When the reversal starts there would be a mad rush to take cover and that in turn will further aggravate the opposite trend.

Not for nothing, the RBI in its monetary and credit policy has cautioned against not hedging currency exposures but that is an advice that seems to have been taken lightly by the market participants.

Behind these entire favourable rupee-dollar movements is the size of forex reserves, now past the $78 billion mark. Other frequently mentioned causes for the rupee appreciation are favourable macro-economic conditions in India prompting enhanced foreign direct investment inflows, the fall in international oil prices (good for the current account) and a satisfactory export performance.

These positive factors might well continue for some more time. However, it would be facile and in certain cases highly dangerous to expect a one-way movement of the rupee. Perceptions, now favourable to the rupee, can dramatically change.

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