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Of late there has been a lot written about the Indian rupee appreciating in value against the U. S. dollar. Since the last week of April, this dramatic rise in the rupee was very much in evidence although it actually started in mid-2002. How
drastically this is going to affect the Indian economy is anybody’s guess—and everybody’s guessing. As in the case of the projected GDP growth rate, there are as many estimates as there are economists.

The reader may well ask: how is this important to me—a common man? The answer depends on how you earn your living. If you are an exporter, you will earn fewer profits in rupees and if you are an importer the price to you (in rupees) of dollar-priced commodities will go down. If you are neither and have a small domestic business that is not based on any imported element, you will not be affected. And if you are a fat-cat government babu whose income is protected by raises in dearness allowance to meet higher living costs, forget it and turn the page to some other article. But if want to get a basic feel for exchange rate propensities and its impact on the national economy, read on.

First, you must understand that when we talk of the value of the Indian rupee, it is always in comparison against the U. S. dollar which is the benchmark currency worldwide and the common currency of international trade. So when we say the rupee is rising, we mean that you can now buy a dollar for a smaller amount of rupees. If the rupee is said to be losing, you have to pay more rupees for the same one-dollar. That is why, when the rupee fluctuates, say, from 47 to 46.5, it means that it has gained strength against the dollar. From Rs. 47 to a dollar it now costs only Rs. 46.5 for a dollar. Remember, the lower the rupee value the stronger it is against the dollar, and vice versa.

There have been some general newspapers and even some politicians who have attributed the current rise in the Indian rupee vs the U. S. dollar to the strength of the Indian economy. We all wish this was so, but it isn’t. There is a flip side to the rising value of the Indian rupee; and that is the falling value of the U. S. dollar. What’s happening is that the U. S. dollar is declining in the world market and, in comparison, the rupee looks stronger. If the rupee’s strength were, indeed, derived from economic fundamentals, it would have shown a rise against other currencies besides the U. S. dollar. This has not happened. In fact it has lost against the Euro.

And why is the U. S. dollar losing strength? Because, it seems that the U. S. A. has deviated from its long-held ‘strong dollar’ policy and migrated to the more traditional concept of devaluation to boost exports. The U. S. Administration, of course, denies this saying that the decline of the dollar was due to market forces. But Corporate America is not being fooled, particularly when the U. S. Treasury Secretary said that the weaker exchange rate would help U. S. exports. They feel that, at a certain point, devaluation is counter-productive especially in a country like America where nearly half of its commercial assets are owned by other countries. A recent review in the Wall Street Journal says that non-U. S. entities own 45 per cent of American treasury bills, 35 per cent of its corporate debt and 12 per cent of the stock market. As long as this inflow of dollars on the capital account balances the current deficit, everything’s fine, but when the deficit starts exceeding the capital account, trouble starts.

The massive investment in American assets by foreign nations was basically because of its strong dollar policy. The stronger the dollar, the more investment was attracted to America which boosted the U. S. currency to even higher levels.

Today, when the U. S. is more than ever relying on foreign capital to fund growth (national savings are at a record low), even a perceived policy of structured devaluation may result in a decline in foreign investment. Even the existing foreign dollars may start looking for other more profitable sites. The rate of return of investment in America was among the lowest, but considered very safe given the avowed strong dollar policy. Foreign investors, especially Asian countries are now seriously considering the merits of continuing their present exposure in America.

This rather lengthy background was meant to present the broad perspective against which the rising value of the India rupee must be considered.

While everybody agrees that exports from India will feel the impact of the strengthening rupee, there are various projected figures as to the decline in India’s export performance this fiscal. The range extends from six per cent to 16 per cent. Add to this the fact that the Real Effective Exchange Rate (comparison to a basket of currencies, not just the
U. S. dollars) of the Indian rupee is perceived to be under-valued, that is, there is a potential for the Indian rupee to rise another three per cent on top of the four per cent it gained since June 2002. Thus, there is a real danger that the continuing value growth of the Indian rupee could conceivably result very adversely on the Indian economy in the days to come.

Our banks and industrialists are starting to worry, although they are putting up a brave face. Besides the almost certain drop in exports (to what degree is debatable), one can add other indicators that make the Indian economic scenario even bleaker. The demand in the U. S. A., Japan and the Euro region, is unlikely to rise sufficiently to make up for the higher costs of Indian exports. Also, the share of Indian manufacturing in the GDP has not improved significantly.

So what is the answer? A firm declared policy and fiscal intervention by the Reserve Bank of India could be the prime tool not only to cap the rise of the Indian rupee but to make industry and finance aware that the RBI is fully cognisant of the impending danger. Unfortunately, the RBI does not appear to know its own mind and decide whether the rising rupee is good or bad for the economy. On May 21, the RBI Deputy Governor said: "We are rather comfortable. We feel that the movement of the exchange rate is adequate considering the happenings in the international market…" On May 22 (the very next day) the RBI dumped a huge amount of dollars on the market in an effort to stem the rupee’s rise. So much for the "comfortable" feeling of the Central Bank.

The forthcoming elections appear to have skewed the thinking not just of the politicians but also our finance professionals. A Central Bank is supposed to lead the economy into profitable environments, not follow the politician-leader who uses the strong rupee as a synonym of a ‘strong India’.

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