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The rupee’s u-turn

The rupee which was on a seemingly relentless upward trend against the dollar for most of last year has more recently changed course. After touching Rs.38.50 amid expectations of further rise, it started depreciating from the beginning of 2008. The decline has been particularly marked since the beginning of May and last week it breached Rs.43 to the dollar. The causes for this sharp reversal are, of course, not difficult to see in hindsight. Forecasting the rupee’s s hort-term trends, however, seems much more difficult. Abundance of dollars in the foreign exchange markets without a matching demand had caused the rupee to appreciate. The runaway global oil prices have inflated the oil import bill and widened the current account deficit, which is expected to be slightly above 2 per cent of the GDP at the end of this year. Oil companies in India would obviously be bidding for a larger amount of dollars to pay for their imports. The mismatch is being further corrected by two other significant developments. Merchandise exports have slowed down in recent months. Secondly, capital flows into the stock market that helped bridge the deficit in the balance of payments can no longer be taken for granted. In fact, the Reserve Bank of India in its recent monetary policy statement has even anticipated reverse flows from India in an extreme case. However, with more than $300 billion of reserves, the RBI is well placed to face any eventuality. For now, however, the sharply depreciating rupee has not invited central bank intervention the way the strengthening rupee had done.

A few other policy measures that were put in place to neutralise the consequences of a dearer rupee need to be reviewed. Merchandise exporters were given incentives to enable them to retain their competitiveness. However, it would be difficult to withdraw such concessions based on very recent rupee-dollar trends alone. In the end, macroeconomic fundamentals along with global factors will decide the immediate direction of the rupee. There has been a resurgence of inflation everywhere on the back of high fuel and commodity prices. Within India, the enhanced provision for subsidies are likely to strain the fiscal situation. However, the Indian economy is expected to grow by 8 per cent this year which, though slightly lower than recent trends, is still impressive. As the global credit crisis dissipates, the Indian growth story may once again turn robust and attract many types of investors. Over the medium-term, the rupee is bound to strengthen.

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