Opinion Finding a new floor

However,for Indian policymakers and businesses at large,the rapidly strengthening dollar creates new anxieties. For,once the choppy seas become calmer the global investors are sure to leave the leaky Titanic and come back to the smaller boats as represented by the relatively fast-growing emerging economies. So,many market players feel it is only a matter of time before the rupee recovers 10 per cent against the dollar and is back to Rs 47-48 levels. But this creates unpredictability and risk for companies which have huge dollar transactions every year.

When the rupee-dollar exchange rate is relatively stable,moving within a range of 5 per cent,up or down,businesses have a sense of predictability. Based on this predictability,companies decide how much dollar exposure should be hedged or cushioned against possible losses caused purely by unforeseen currency movements. Until recently,there was much greater predictability and stability on the exchange rate front. Therefore businesses left a large part of their dollar exposure uncovered. Now these corporates are far more vulnerable and are being advised by the RBI,through banks,to have a proper hedging policy. For instance,banks are advising companies borrowing in foreign currency to hedge their exposure much more than in the past.

Suddenly,the government and the RBI are betraying some discomfort in regard to currency stability. The RBI has explained the rapid fall in the rupee as a global phenomenon where all emerging market currencies have fallen substantially against the dollar. However,emerging market currencies such as those of China,Indonesia,South Korea,Brazil and Russia have on average fallen less than 5 per cent against the dollar since January this year. In comparison the rupee has fallen 17.5 per cent and analysts say it could go down another 5 per cent over the next few weeks. In November itself the rupee fell by over 6 per cent.

The government has also blamed the eurozone crisis for the sudden decline in the rupee’s exchange rate.

RBI Governor D. Subbarao said on Tuesday that the currency movement could get reversed once the euro situation stabilises. There has been some problem with the way the RBI communicated its exchange rate stance initially. One RBI deputy governor publicly declared last week that the central bank would intervene only if there is volatility in the currency movement. Now volatility is generally defined as a dramatic two-way movement creating too much uncertainty. The statement gave the impression to the market that a one-way movement was fine with the RBI. This caused further downward pressure on the rupee as the market read the RBI statement to mean it would not intervene if the rupee depreciates more. Thus the one-way movement got accelerated and then the RBI tried to stem it by a sort of tepid intervention earlier this week.

But now everyone has begun asking how much more will the rupee go down? The RBI is trying to come up with some technical explanation that,on a real effective exchange rate basis,the rupee is reasonably valued. However,until six months ago the market had the impression that the fair value was in the range of Rs 46-48,and that the RBI would not allow the rupee to depreciate beyond Rs 50,which was seen as an important psychological barrier. This barrier has got smashed.

The easy manner in which Rs 50 got breached and has created the perception that Rs 55 to a dollar is par for the course was a bit like an ambush. By allowing this,the government and the RBI may have further fed the suspicion that India’s economic fundamentals are not as strong as our economic managers have been claiming all this while. The inflation differential between two countries is a key determinant of exchange rate movement. India’s policymakers have clearly failed in creating a stable inflation expectation. The deputy chairman of the Planning Commission,Montek Singh Ahluwalia,admitted last week that the government had failed to carry credibility in the way it had managed inflation so far. Drift in policymaking has added fuel to the fire. This will not improve as the opposition parties are refusing to cooperate with the government on crucial legislation.

From a macro perspective,the only positive one can see in a depreciating rupee is that it will discourage imports and shrink the trade deficit,thus making the balance of payment management easier. For the net foreign capital inflows of about $75 billion projected by the Prime Minister’s Economic Advisory Council for this fiscal are looking like a tall order now. A slightly undervalued rupee should normally encourage more capital inflows. But if the euro situation worsens,that too may be in doubt.

The writer is managing editor,‘The Financial Express’,mk.venu@expressindia.com