Rupee @ 30? Oh dear!

As the rupee hit a near-decade high of 39.16 to the dollar on November 7 (it was at 39.49 on December 7), it is becoming clear that the Indian economy must learn to live with a stronger rupee over the medium term at least. Gerard Lyons, Chief Economist and Group Head (Global Research), Standard Chartered Bank, said recently that the rupee, driven by the continuous flow of foreign capital into the country, may well appreciate to Rs 30 against the dollar over the next five years.

“There is near unanimity on the general upward trend of the rupee value,” says Shubhada Rao, Chief Economist, YES Bank, adding that the “fundamental issue” is that the economy’s “absorptive capacity” does not match the huge inflows.

As this magazine goes to the press, the rupee was again buoyant on expectations that the US Federal Reserve, at its meeting on December 11, will cut rates again by 25 basis points to 4.25 per cent, making Indian debt securities, bearing a higher interest rate, more attractive. Vivek Moorthy, Professor of Economics at IIM Bangalore, says: “The RBI has no clue about how it wants to influence the exchange rate.” The central bank does not have the wherewithal to engineer the scale of intervention needed to cope with the huge capital inflows seen over the last eight months, adds D.K Joshi, Principal Economist, CRISIL.

And though RBI has been encouraging greater capital outflows, the effect has not been significant, points out Samiran Chakraborty, Chief Economist, ICICI Bank.

What's in store General uptrend in the rupee value over the medium term  Volatile rupee-dollar exchange rate  Likelihood of asset bubbles (such as in real estate) caused by foreign money  Uncertainty over fuller capital account convertibility; likelihood of more capital controls Greater need for hedging against currency risks Increasingly complex monetary policy.managing exchange rate risk, inflation, trade policy, capital market development, and issues relating to production, investment and growth What India Inc. should do Reduce reliance on the US market and the dollar Take advantage of foreign low-cost destinations Improve productivity and operational efficiency  Hedge against exchange rate risk Consolidate

While RBI and the government pull different levers of an increasingly complex monetary policy, the economy is suffering.

The export target for this year has been revised downwards from $160 billion (Rs 6.4 lakh crore) to $140-145 billion (Rs 5.6-5.8 lakh crore) amid a massive slowdown in the exports of textiles, leather and handicrafts.

“The rise in the rupee value will adversely impact the entire economy and not just exports. A higher rupee will lead to cheaper imports, which will hit domestic industry and encourage higher consumption of oil,” says Rajiv Kumar, Director, Indian Council for Research on International Economic Relations (ICRIER).

However, not everyone agrees with Kumar. “The impact of the rupee rise is sector-specific. The textiles, leather and handicrafts sectors suffer the most because they neither have a natural hedge against currency risk while importing inputs nor great power for price renegotiation. I do see a host of benefits of the rupee rise, such as cheap imports of capital goods,” says CRISIL’s Joshi.

IT and ITES companies are already trying to reduce their reliance on the US and the dollar and focus instead on European and Japanese markets. Some of these companies are also setting up centres in low-cost countries of Europe and Latin America, says Aneesh Jhaveri, Associate Director, KPMG. “Larger IT players are also renegotiating prices, asking for 9-10 per cent higher billing and often getting 5-6 per cent.

The rising rupee has also given IT players the incentive to improve their operational efficiency on which they have never concentrated before,” he adds. ICRIER’s Kumar favours more capital controls, especially to curb the “hot” FII money. “But most importantly, we need to boost the absorptive capacity of the economy before allowing more foreign capital inflows,” he says.

YES Bank’s Rao says the regulators have done well to usher in greater transparency in FII inflows and restrict access to external commercial borrowings (ECBs). But despite these, the inflows continue unabated, putting the rupee under further pressure.

The bottom line: the coming year will be difficult, and the government will have to calibrate its policy responses very carefully to tide over this development.