… there is no escape—once the hour comes, rupee has to fall

The rupee has to fall! There is no wonder if it has touched its historical low of 53.41 per dollar after touching intra-day low of 53.47 and a high of 53.12, as the importers rushed to cover their short term as well as long term—three months and six months forward—while exporters watched from the sidelines.  

Obviously, the known high demand emanating from oil companies coupled with the emerging demand from companies that are redeeming their external commercial borrowings has made the situation further worse, particularly, with no matching inflow of dollars. Even the intervention of the Reserve Bank of India in the currency market on May 2—consequently for the second day—could not generate the desired effect, though to a certain extent, it arrested further fall. 

Surprisingly, even when the dollar was weakening against other major currencies—the dollar index against six major currencies of the world stood at 79.13 on May 2 as against 78.88 on May 1—the rupee could not gain any advantage out of it. Indeed, the rupee has lost about five percent against the dollar during the current fiscal.  

In January 2012, the rupee was hovering around 48-49 per dollar by virtue of various restrictions the RBI had imposed on the Forex market. But since February, the rupee has started weakening, and come May, it has fallen to 53 plus per dollar, that too, despite there being all the restrictions imposed by the RBI earlier in place. 

Now the moot question is: Why is the rupee continuously weakening?  Commonsense tells that the fall is primarily due to poor inflow of foreign currency into the domestic market. But if we look at the data released by the RBI,  we feel that the inflows are not that bad, for as much as $60 billion flowed in during the first 11 months of fiscal 2011-12, which is no small amount compared to the previous year’s inflows—$70.1 billion during 2009-10, $64.4 billion during 2010-11.

So, the obvious next question is: Where, then, lies the problem?  The answer may lie in the nature of capital inflows that India is experiencing. Forex capital inflows are mainly in the form of ‘direct investment’, which is of long-term nature, and ‘portfolio flows’, which are of short-term nature and are purely of financial nature. Now, looking at the data pertaining to portfolio flows, one observes a fall in this segment: as against a flow of $32.4 billion during 2009-10, and $31.5 billion during 2010-11, the inflow for the first 11 months of 2011-12 is reported to be around $18 billion. This phenomenon reveals that the apparent cause for the recent volatility in the rupee-dollar exchange rate is the gyrations in the FII’s investment in our stock market.  

That said, we also cannot be ignorant of the fact of the widening gap between the value of rupee and the level of Sensex. This leads to a possibility of enhanced speculation in the currency market, which incidentally is today more possible owing to the availability of derivative products for trading. 

Yet, that’s only one dimension of the problem. The real challenge to the rupee is more from the worsening balance of payments position. The exports, no doubt, have recorded a rise of 21% at $303 billion, but at the same time, the imports have grown up by a much higher percentage—32%—by touching a figure of almost $485 billion. The trade deficit that stood at $185 billion, has already touched 10.5% of GDP.The external obligations of the nation have already exceeded the reserves of $ 295 billion. And there appears to be no respite from the widening trade deficit, for the international oil prices are soaring up while our demand for oil is also rising unabated. 

Unfortunately, the government appears to be doing nothing to curb the demand for oil—it is not raising the prices of petroleum products to their actual cost of production. What an irony in a free market economy! Nor does the government appear to be enthusiastic about launching new reforms that would boost the investors’ confidence, paving the way for more inflows of foreign exchange, that too, in the form of direct investment.  

But when the government is in a state of—to borrow the words of chief economic advisor Kaushik Basu—‘policy paralysis’, and apparently no significant action is taken to improve the fiscal deficit, there appears to be little or no scope for the macroeconomic scenario to improve. Which is why there is not much hope for fresh investments coming from abroad.  

Cumulatively, rupee cannot escape volatility, and no wonder if it even weakens further.  
At the most, the RBI can,manage its fall by arresting speculative trading!

-         GRK Murty