RUPEE ON A HIGH

RUPEE ON A HIGH 

ByRobin Roy (Associate director)
PricewaterhouseCoopers Pvt Ltd, Mumbai                                                                                                       
An important indicator of any country’s economic strength is the general stability in exchange rates. Continuous fluctuation in the rates adversely affects the
balance of payments of a country The volatility in the foreign exchange rates depends on a variety of macroeconomic factors. Some of them are:

·        Trade flow (import and export) between countries

·        Flow (relative ease) of capital between the countries

·        Relative inflation rates

·        Fluctuation bands (limits) on exchange rate imposed by certain countries

·        Merchandise trade balance

·        Rate of inflation in the country

·        Flow of funds between the countries for the payment of stock and bond purchases

·        Short term and long term interest rate differentials

Exchange rate is determined by demand and supply of the currency for trade and also by international investments in the country— both foreign direct investment and foreign institutional investors. The appreciation of rupee would indicate a strong economy but at the same time it also results in loss of export competitiveness. The RBI takes corrective measures to contain the appreciation of rupee by allowing the exchange rate to be determined by market forces and also by buying and selling foreign exchange.
Exchange rates are important for any country as they determine the level of imports and exports. If a domestic currency appreciates with respect to a foreign currency, imported goods will be cheaper in the domestic market. If the country has a strong currency, its goods become more expensive in the international market, which results in impaired export competitiveness.
As per the Confederation of Indian Industry  exports declined by 4.7 per cent from around US $184 billion at the end of 2008- 09 to US $176.5 billion at the end of 2009-
10 due to the appreciation in rupee. Indian rupee has appreciated more than 12 per cent against the US dollar during the period from March2009 to May2010. The balance of payments data, recently released by the Reserve Bank of India, indicates that the net portfolio investment inflow between April and December 2009 amounted to US $23.6 billion as compared to an outflow of US $11.3 billion in 2008.
Movement in exchange rates has a significant impact on a company’s returns. The profitability of multinational companies gets affected as foreign exchange rates may make the local currency more valuable. It also affects the local companies’ ability to sell their products in foreign countries.
The sharp movement in rupee/dollar exchange rate in 2006-07 (rupee appreciating) witnessed by India’s export-oriented sectors (especially software and textile) reduced their export competitiveness forcing them to seek government intervention. Whereas, when the tide turned in fiscal 2008-09 and the rupee began depreciating sharply against the USD, import-oriented sectors were in trouble. The rupee has gone up by 5.6 per cent since September 2010 as a result of sustained capital inflow. In 2010, the fund inflows from FITs have been $24 billion and the rupee has gone up by 4.4 per cent, primarily, because of an impressive initial public offering pipeline.
As seen in the year 2007-08, the rupee appreciation is caused mainly due to FIT inflows into the capital market. These inflows are purely speculative and hedge fund money which is intended to jack up the indices and take a u-turn, as and when they decide to book profits, warns Dhananjayan, financial advisor, Fore Derivatives Consumer  Forum, Tripura. “This kind of uncontrolled capital flow, that artificially creates volatility in the currency market, is unhealthy for the real economy,” he says.
Similar scenario in 2007 was grossly ‘misused’ by banks that acted on behalf of their US counterparts, selling ‘illegal’ derivative contracts to gullible exporters across the country, causing a lot of strain in the economy, he adds.

According to the Asian Development Bank (ADB), India’s growth forecast for the current fiscal is 8.5 per cent, but it expressed concern over persistent high inflation and rising value of the rupee which could undermine future economic expansion. The multilateral lending agency, that had projected a growth rate of 8.2 per cent for 2010-11 in April, has retained its earlier projection of 8.7 per cent for 2011-12. According to the ADB Outlook Update, a
series of annual economic reports on the developing member countries of the ADB, growth is being supported by robust investment increased capital inflows, and stronger industrial output buoyed by rising consumer demand. ADB also warned that the rising value of rupee does not augur well for the Indian economy in the corning years. Rupee appreciate more than 11 per cent in real terms between August 2009 and 2010, it added, and “poses an additional challenge for policy makers as they seek to maintain high growth while winding back the monetary and fiscal stimulus measures used to help the economy recover from the global economic crisis”.
High inflation and rupee’s sharp appreciation, it added, could erode India’s export competitiveness and its plans to further expand economic growth to 9-10 per cent in coming years. Currency forecasters bet the rupee will drop in 2010 and climb in 2011. According to some experts, the rupee is only going to get stronger in the longer term (5—10 years) based on the fact that the Indian economy is going to grow much stronger than any other economy in the world (except China).
According to Jong-Wha Lee, ADB chief economist, a well-grounded and robust recovery for India would depend “on the ability of the various policymakers to coordinate effectively among themselves to achieve macroeconomic stability, and striking the right balance between growth, inflation and competitiveness objectives”