Rupee should not harden further

October 14, 2013

(Any opinions expressed here are those of the author and not of Thomson Reuters)

The rupee has recovered over the past few weeks after falling to a record low of 68.85 per dollar in August. After a period of unease, the finance ministry and the Reserve Bank of India can now take it a little easy. But care needs to be taken that the rupee is not driven up further.

Speculation about the end of the U.S. Federal Reserve’s bond-buying programme in May affected global currencies and the rupee was not alone in this predicament. The announcement had created a scare about the tapering of quantitative easing. That would have dried up liquidity that the market had got used to. The Brazilian real, Indonesian rupiah, and the Indian rupee were the principal losers.

The market scare hit sensitive FII investment and the total net outflow from India between June and August was 226 billion rupees. That hit the stock and currency markets. The rupee, which was at 50-51 to the dollar in May, was near 69 in August.

The subsequent hardening of the rupee was partly due to a series of measures introduced by the RBI to curb speculation by increasing short rates and making it easier for banks to borrow dollar funds from abroad. More important was Federal Reserve Chairman Ben Bernanke’s surprise postponement of imminent QE tapering. That brought relief to the market and most currencies recovered.

Since October, there has been a reversal of fortunes. The shutdown of the U.S. government has created doubts about the dollar itself. If significant steps are not taken before Oct. 17, there would be further problems with either the government required to cut expenditure, ushering in recession, or defaulting on debt repayment, which would precipitate a financial crisis. In either case, the dollar will weaken.

Perhaps an acceptable solution will emerge. Besides, Janet Yellen, who would take over from Bernanke as chairperson of the Federal Reserve, is Keynesian and the market expects that quantitative easing will continue for some more time.

The international financial environment is definitely changing, helping exports to rise and the rupee to harden. It is no wonder that the RBI has been unwinding some of the restrictions it had imposed earlier. The possibility is that the rupee, though it has found some stability, may climb. That’s because the dollar will be weaker and India’s current account deficit will improve.

From $21 billion in the first quarter, it appears that the deficit in the second quarter may be negligible. That will create room for the rupee to jump if left to itself.

The possible hardening of the rupee is what needs to be prevented, with the RBI buying dollars to build its depleted foreign exchange reserves. At 60-61 to the dollar, the rupee reflects its real value corrected for inflation.

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